November
20
Tags
Buying into Big Tech: Strategic or are we now the Greater Fool
- Big Tech’s Market Influence
- Walmart’s Earnings Report as an economic indicator
- Small Cap Stocks – Is this the beginning of a sustained rally?
- Fed – Can they pull off a soft landing
- When the Fed will cut
By David Nelson, CFA CMT
Bad news is good news. Good news is bad news. That’s been the guiding light for investors the last 22 months. It wasn’t the only focus, but it was certainly the force behind most decision making. God forbid the economy, or the consumer were strong. That would mean only one thing. The Fed would have to slam on the brakes and not let up. Outside of energy that mindset rained on just about every sector of the economy last year.
Bloomberg Data
This year, we exploded out of the gate. By the end of March, the major secular trend had taken hold. Large cap secular growth driven by tech and telecommunications, rocked higher. Consumer discretionary led by Mega-Cap heavyweights Amazon (AMZN) and Tesla (TSLA), were close behind.
So here we are in November, on the heels of a better than 10% rally that lifted all asset classes. Small caps, Mid-caps, bonds, even utilities bounced hard. Were the pundits finally right? Small caps and other stocks left behind were ready to outperform?
S&P 500
Bloomberg Data
Dump your Microsoft, Apple, Amazon, Alphabet and pile into their smaller brothers and sisters. That’s been the rallying cry for the last several weeks.
Unfortunately, small companies are generally more tied to the economy. While the prospect of lower interest rates helps all stocks, small caps need one more thing. They need an economy that is picking up steam, not one that may finally be rolling over.
Walmart’s (WMT) earnings report may have rained on that parade. While they raised guidance it was short of street expectations, prompting calls that the consumer was finally tapped out.
Management was concerned that deflation was starting to kick in and customers wouldn’t have to pay as much.
I guess that’s bad for Walmart, but is that how we should really look at this report? Trust me, it matters. The answer to that question might be the difference between a bull and bear market. Welcome to the Money Runner. I’m David Nelson.
Walmart
Bloomberg Data
Walmart was probably one of the more important earnings reports last week. Cisco (CSCO) was important, too, because it’s a sign that enterprise spending might be slowing. I’m going to come back to Cisco in a minute.
The Dark Side of Higher for Longer
Walmart is often a report card on how good or bad the consumer is doing. The strength of the consumer this year is astonishing given all the headwinds. Higher rates are a continued drag on the economy, and of course, the consumer. Even in Goldman’s report this week, they talk about the dark side of higher for longer. I agree with that statement. Eventually it corrodes the financial plumbing, and you start to feel it.
Bloomberg Data
You certainly felt it in the banks earlier this year. Today, ten-year rates are above where they were back in March, a level that in part was responsible for the collapse of Silicon Valley and Signature banks.
The biggest concern on the Walmart call was that DEFLATION was going to affect future sales. Do the math. If consumers buy the same number of items and prices are lower, that forces declining sales. Well, the street certainly didn’t like that and sent shares down over 8%.
Let’s try to unpack the Walmart news a little differently. Yes, declining sales are a negative for Walmart, in fact, any company. But is it really bad for their customers? I don’t think so.
In fact, in the long run, it might even be good for Walmart. Customers might take those savings and use it to buy discretionary items that have better margins.
Bloomberg Data
Traders didn’t look at it that way. Following the Walmart news, they piled back into large cap, secular growth stocks with Microsoft (MSFT), leading the way, breaking out to an all-time high.
Buying into large cap tech is a defensive move. Think of it this way. Most industries have much lower margins than technology companies. In retail you’re talking about single digit margins with little room for error. You can go from making money to bleeding cash in a New York minute.
MSFT
Bloomberg Data
The huge margins in technology offer a lot of breathing room. Microsoft net margins are over 30%. Nvidia, over 50%. Sure, when things get tough, business slows down for them, too, but those margins provide a lot of breathing room.
NVDA
Offense
The offensive move is buying into small caps, midcaps, and other companies more tied to the economy. If small caps are going to lead the next leg of a bull market entering its second year, good news is going to have to be good news.
Therein lies the question:
Is the recent strength in small caps a sign that the economy is truly getting stronger or is it just a reversion to the mean from oversold levels. Unknown?
I wish I had the answer to that question but let me just say this.
What you’re really asking is the following: Is it safe?
On the heels of a monster move off the October lows with some stocks up triple digits this year, can I buy into the rally or should I continue to hide out in money markets and TBILLS?
Look, if you’re not in the market already, it’s too late to go all in, but you can start scaling in. One of the biggest risks has been an aggressive Federal Reserve, but even that is slowly coming to an end.
What’s priced in
We can debate the timing of a cut. We can even debate that a cut is coming. But what isn’t up for debate is that the Fed is done raising rates. The bad news is that the market has already priced that in.
Interest Rate Probability
Bloomberg Data
You can see that in interest rate probability charts. Few are looking for a rate hike and most of the discussion is about when the cuts start and how many. Soft landing? Yeah. That’s priced in too.
The Greater Fool
Will the Fed be able to stick the landing? The answer to that question may be the difference between making money or waking up the next morning, the greater fool.
And now something completely different
I am going to try something new this week. It’s easy to talk about the trades that worked or a moment in time where you just couldn’t do anything wrong. Eventually the market humbles us all.
Report Card
Let’s give ourselves a report card. What did we get right? What did we get wrong?
All in. I gave myself a C-. Trading in our main portfolio was not the smartest in the world. We had back-to-back inflation reports that rocked markets higher. CPI & PPI, both came in softer than expected.
CSCO 1 Year
Bloomberg Data
The one decision I got right was selling half our Cisco (CSCO) right in front of earnings. It had fallen out of my quant model for a variety of reasons, and it’s traded poorly since announcing a buyout of Splunk. I thought about selling it all, but in the end, we went halfway. You had a pretty big decline in the aftermarket, down about 11%, and that followed through the next day.
I made a decision early the next morning and dumped the rest right after it opened. I’m okay with that. I thought that was a smart move.
Unfortunately, that same morning, I had to deal with Walmart, which also missed expectations. I had a full position on so that one hurt. It opened down 5 or 6%. We dumped about 40% of it very close to the open. It ended the day down 8%.
Bleeding to Death
For the rest of that day, retail was under siege. My screen of retailers and consumer discretionary stocks looked like it was bleeding to death. I looked at our Ross Stores (ROST) position, which was set to report at the close. We had a small profit. I didn’t want to lose it.
Look, Ross is a solid company, but not cheap. Trading at 22x next year’s earnings, I knew that if there was any hiccup in the report, it could suffer a pretty big decline, maybe even worse than Walmart. I could have sold half, but in the end, I elected to sell it all.
Bloomberg Data
Well, the numbers were fine. In fact, same store sales were better than the street by a wide margin. The stock was up 8% after hours and one of the strongest performers the following day. Like I said, C-.
NVDA
We are coming into a short week as we head into Thanksgiving break. Make no mistake, this week will be anything but quiet.
Bloomberg Data
One of the most important earnings reports of the year is on deck with Nvidia (NVDA) set to release earnings Tuesday after the close. Holiday week or not, this one will move markets.
The stock is up 230% this year with a lot riding on the success or failure of this A.I. heavyweight. I’ve said artificial intelligence is the most important investment theme of my career. A hit or miss won’t change that.
I’m David Nelson and this is The Money Runner.
*At the time of this post some funds managed by David were long MSFT, AMZN, GOOGL, WMT & NVDA
DAVID NELSON, CFA 