Deciphering the Earnings Extravaganza
The big US stocks, stalwarts of markets and investor portfolios, are riding high on the wave of another earnings season. The quarter has been record-breaking, showering the financial realm with phenomenal results. However, beneath the surface, the growth of underlying profits lags far behind the soaring stock prices of major companies. This dissonance has pushed valuations into perilous bubble territory, sounding alarms for the emergence of a new bear market.
Quarterly Insights: The Battleground of Bulls vs. Bears
Prevailing stock prices often dance to the tune of herd psychology, greed, and fear, obscuring the true fundamental performance of companies. However, quarterly results act as a beacon of truth, cutting through the noise and revealing the actual state of affairs. This quarterly ritual of companies filing comprehensive reports with the US Securities and Exchange Commission offers a snapshot of their financial health and strategic vision.
The Pulse of Q1’24: Riding the Wave of Euphoria
In the arena of stock markets, big US stocks appear to be on a winning streak. The flagship stock index, under the dominion of these corporate giants, surged an impressive 10.2% in the frenzied Q1’24. While the soaring index notched 22 record closes during the quarter, the relentless march skyward pushed it to dizzying heights of extreme overbought territory. As the market exuded euphoria and greed, caution flags were raised, hinting at a looming market correction.
Market Reflections: The Unsettling Specter of Concentration
The US stock market landscape is becoming increasingly top-heavy, a harbinger of substantial risk. The top 25 component stocks of the S&P 500 now command a staggering 46.8% of the index’s total weight, highlighting a concerning trend towards extreme concentration. This growing reliance on a select few stocks renders the market fragile and susceptible to shocks.
The Dominance of the Magnificent 7: A Market within a Market
The Magnificent 7, comprising tech behemoths like Microsoft, Apple, NVIDIA, and others, lord over the US stock markets with an iron grip. Accounting for a colossal 29.1% of the S&P 500’s total market cap, these titans overshadow the remaining 493 stocks by a significant margin. Their meteoric rise, almost doubling the broader market’s gains, underscores their dominance but also raises concerns over sky-high valuations.
The Peer Pressure Paradox: Fueling the Frenzy
The performance of the Mag7 isn’t solely based on fundamentals but is also propelled by the ominous force of peer pressure. With professional fund managers compelled to overweight these tech giants to stay competitive, the herd mentality prevails in the market. The relentless pursuit of gains, driven by the success of a select few, risks creating an echo chamber of groupthink with far-reaching consequences.
Mega-Cap Tech Giants Face Turmoil Amidst Rising Challenges
Revenue Surges and Turbulence Among the Mag7
Despite boasting massive scales and sizes, the Mag7 witnessed a remarkable 13.3% Year-over-Year surge in total revenues, reaching a staggering $456.3 billion in the first quarter of 2024. A standout performer was NVIDIA, capitalizing on the AI wave, as its sales soared by a jaw-dropping 265.3%. However, cracks are starting to appear in the armor of these market behemoths. Both Apple and Tesla experienced a decline in sales last quarter, down by 4.3% and 8.7% Year-over-Year, respectively. These mega-cap tech giants are heavily reliant on consumer demand, which seems to be wavering.
Market Challenges and Shrinking Consumer Budgets
In recent years, American households have faced constraints on their budgets. While overall inflation rates have moderated, prices continue to hover significantly higher than pre-Biden-Administration levels. With essential expenses such as food, energy, housing, and insurance consuming a larger portion of income, people have less discretionary funds available for luxuries like smartphones and electric vehicles. This economic shift is beginning to impact the likes of Apple and Tesla.
Apple’s Struggles and Diminishing Growth Trajectory
Apple, known for its quarterly revenue breakdown by geographic segments, observed a 1.4% Year-over-Year slump in the Americas during Q1. However, the more substantial dip of 8.1% Year-over-Year in sales from Greater China posed a more significant challenge for the tech giant. The Chinese government’s anti-American stance is driving consumers towards domestically manufactured smartphones like those produced by Huawei and Vivo, affecting Apple’s market share.
Tesla’s Dilemma and Market Saturation
Tesla faces even more significant hurdles due to the higher price point of its electric cars. With a shrinking pool of American consumers who can afford Tesla vehicles and a limited market of electric car enthusiasts who already own these vehicles, the company is trying to sell in a saturated market. Added to this, Tesla’s customer base leans left politically and has reservations about Elon Musk’s stance on free speech, further complicating the company’s prospects.
Shifts in US Stock Dynamics Outside the Mag7
Interestingly, the 18 largest US stocks outside the Mag7 witnessed a robust 11.4% Year-over-Year growth in sales, almost matching the revenue growth of the mega-cap tech giants at 13.3%. This surge can be attributed to alterations in the composition of the top 25 companies in the S&P 500, with larger corporations displacing smaller ones from the elite ranks. For example, Costco and Bank of America supplanted Coca-Cola and PepsiCo, triggering this shift.
Disparities in Earnings Performance and Industry Dynamics
The disparity between the mega-cap tech firms and other companies was starkly visible in bottom-line earnings in the last quarter. While the Mag7’s GAAP profits soared by a staggering 50.0% Year-over-Year to $105.5 billion, the earnings of the next 18 largest US stocks plummeted by 23.5% to $81.4 billion. Noteworthy performers such as Amazon and NVIDIA saw exceptional growth, but sustainability concerns linger.
Challenges for NVIDIA and Emerging Competition
NVIDIA, celebrated for its advancements in artificial intelligence, faces impending challenges. While the demand for its AI-focused GPUs has been robust, competition looms large as other chipmakers and tech giants develop their AI chips. This onslaught could erode NVIDIA’s market share and diminish its profitability in the long run. The era of sky-high margins derived from AI chips may be drawing to a close.
Varied Performance and Pharmaceuticals’ Contribution
The contrasting earnings trends among US stocks extend beyond the tech sphere. Berkshire Hathaway’s adjusted earnings indicated a remarkable 10.9% Year-over-Year surge in Q1’24, excluding the effects of unrealized gains and losses. The pharmaceutical sector, notably companies like Eli Lilly, Merck, and AbbVie, witnessed substantial earnings growth fueled by soaring demand for drugs like GLP-1 agonists, indicating diverse dynamics across industries.
Uncertainties in the Pharmaceutical Landscape
The surge in demand for GLP-1 agonist drugs presents both opportunities and uncertainties. While sales of such medications have skyrocketed, concerns linger regarding their long-term efficacy and the sustainability of demand. The expensive nature of these drugs, coupled with the need for ongoing injections and lifestyle modifications, pose challenges to widespread adoption. The evolving landscape of pharmaceuticals remains a subject of ongoing debate.
The Looming Storm Over Big Pharma Stocks
The stock market remains robust, but a closer look reveals a troubling scenario. The top 25 big-pharma companies in the S&P 500 are displaying absurdly high valuations. Exiting the last quarter, companies like LLY, MRK, and ABBV boasted extreme trailing-twelve-month price-to-earnings ratios of 133.4x, 879.7x, and 66.9x, respectively, leaving other giants like NVIDIA and Amazon in the dust. This overvaluation paints a grim picture for the future.
Valuations: A Major Problem
The major concern lies in the sky-high valuations of these big-pharma stocks, especially when compared to historical benchmarks. The top 7 companies averaged TTM P/Es of 43.2x at the close of Q1, while the following 18 companies averaged a staggering 82.2x. Historical data suggests that valuations exceeding 28x mark the onset of market bubbles, a figure twice the longstanding fair value of 14x. This, combined with overvalued tech giants, places the market in precarious territory.
The Looming Reckoning
Extreme overvaluations often herald impending market corrections. These bubbles inevitably burst and lead to a phase of sell-offs. Bear markets emerge to readjust stock prices to align with earnings levels. While bubble valuations can persist for some time, a reversal is inevitable. It’s not just the tech sector; even excluding big-pharma outliers, the next 18 major US stocks carry concerning 26.6x P/Es, painting a concerning picture for the broader market.
Despite record profits, substantial buybacks, and strong cash flows, the big US stocks are significantly overvalued. Should the US economy falter, these overvaluations would exacerbate the situation. A downturn would amplify the effects, pushing valuations higher and increasing the risk of a severe bear market.
Lessons from History
History serves as a potent reminder of the dangers of market bubbles. Major bears originating from bubbles can halve stock prices quickly. The S&P 500 experienced significant declines following bubbles in the early 2000s, highlighting the vulnerability of overvalued markets to severe corrections. Even minor corrections showcase the vulnerability of stocks, with tech giants faring worse than the broader market.
Preparing for the Storm
Given the current scenario, investors must exercise caution. The looming stock bubble presents the risk of a major selloff surpassing the 20% threshold. Protective measures such as trailing stop losses and diversification away from overvalued tech stocks can mitigate risk. Allocating capital to counter-moving assets like gold and its miners could provide a hedge against potential losses.
Gold: A Safe Haven?
While gold traditionally remains unpopular during stock bubbles, its recent surge to new highs presents an opportunity. Fueled by strong Chinese demand and central bank buying, gold has already spiked by 31.2% in a short span. As US stock markets waver, gold’s appeal is set to increase. Investing in gold stocks, poised for significant gains as gold’s uptrend continues, could offer a shield against market volatility.
Amidst stellar Q1 performances, the overvaluation of big US stocks remains a cause for concern. Led by tech giants, robust revenues and earnings contrast sharply with inflated valuations. A downward correction seems imminent, challenging investors to navigate the storm and seek refuge in undervalued assets like gold.