Making sense of the markets this week: August 9, 2021

The inside story on earnings and revenue for S&P 500’s Big 6

In terms of valuation, the largest companies on the S&P 500 are Apple, Microsoft, Alphabet (Google), Amazon, Facebook and Tesla. These are the behemoths that have been helping to drive the U.S. stock market higher. Many of the tech companies permeate our lives and have become almost utility-like. 

Amazon dominates the e-commerce space in North America (despite the earnings and incredible success of Canadian tech darling Shopify, which we looked at last week).

Neither is Tesla a stranger to this space. The star of the electric vehicle (EV) movement has impressive growth numbers and growth potential. 

Trinity Asset Management offers tables for Big 6 earnings and revenue projections, and Barron’s recently looked at the Top 5, as reported in Seeking Alpha… 

“All the above names are very volatile. In the earnings preview, to the mega-cap names, the trends were obvious. For the overall SP 500, the mega-cap names have not only market-cap influence, but “earnings weight” influence. As was written on this blog this weekend, the overall increases in forward SP 500 EPS and revenue estimates are substantial, not a s mall amount due to last week’s mega-cap earnings reports.”

Earnings growth has been more than impressive in this second quarter of 2021, though I have often pointed out this is likely the earnings peak for growth rates.

And from the tables offered in the Trinity link, you can see analysts are ratcheting up their revenue and earnings projections for most of the Big 6. Analysts do not see the growth and the dominance of mega companies ending any time soon. These companies are putting up big numbers and there are expectations that there is more to come. 

The tables offer a sense of the potential for future growth; you can also get a sense of any change in sentiment from analysts, who feel that Amazon and Facebook offer the greater growth potential of the gang. I own Apple and I’m not surprised to see more modest growth projections. It is more than difficult for mega stocks to deliver mega growth. That said, I still love my Apple, as it offers a wonderful series of growing business lines that take the pressure off of iPhone sales. 

And that is perhaps the most surprising stock market trend for these mega U.S. stocks: They do continue to grow in spectacular fashion. If you build a portfolio of individual stocks, you want to own that growth. The question is always: At what price do you want to own that growth potential? These stocks are expensive and you are paying up for future earnings growth—you are buying growth potential that has not yet arrived. Of course, we might have great confidence that the earnings and revenue growth will arrive over time. 

But these names (and, in turn, the market) are vulnerable to any change in overall economic prospects. If sentiment and overall economic health changes, the growth names can tumble hard, as those revenue and growth projections might quickly evaporate. 

Be prepared and aware that there are greater risks when expectations are high. In the end it is the actual earnings over time that will drive investment success. 

As investors, we might play offence and defence (more defensive, perhaps boring, stocks and bonds, and other portfolio risk-managers in the mix) depending on our timeline and situation. If you are near retirement or in retirement, hopefully you have been rebalancing any of your generous U.S. stock market gains. A young investor might slant very much to growth, as they have decades to allow for recovery from any stock market and economic hardship. 

Those who own the cap-weighted stock market funds might keep the above in mind. These wonderful companies are a main driver of past success and they are also a driver of forward-looking sentiment. You don’t have to own the market. You can also adjust your asset allocation away from U.S. stocks if you feel the market and analysts are a little bit too “optimistic.”

Winners and losers in the (hybrid) work from home economy

As has been suggested in this space, the future of the workplace is likely a hybrid scenario. We will continue to work from home and we will also be in the office. Many of the changes in behaviour influenced or necessitated by the pandemic will be permanent. We are changed forever. 

Back in June we discussed how Canadians don’t want to return to the office full-time. From that post… 

“Almost 60% of those surveyed said they would prefer to return to the office part-time or occasionally, while 19% said they never want to go back.

“The top three reasons for preferring to continue to work from home were convenience, saving money and increased productivity.

“Employers will likely have to accommodate worker ‘demands’.” 

This Vox article looks at what empty offices mean for American cities—and workers. Who wins and loses in the remote work revolution? 

From that Vox post … 

“There’s a lot of potential good in the rise in remote work. It can provide flexibility, cut down commuting time, and make many workers more productive and happier. But the work-from-home shift has important implications for people who can’t, and many of them are negative.” 

In the early stages of the pandemic it became obvious that the virus would pick on those who were health-compromised, as well as the more economically-disadvantaged. 

“‘This revolution in flexibility is not a bad thing,’ said Rakeen Mabud, managing director of policy and research and chief economist at the Groundwork Collaborative, a progressive think tank. ‘But it feels like we’re trading the well-being of the privileged for the well-being of those who work at coffee shops, at lunch counters, that depend on office workers. That’s the inevitable outcome that’s predicated on inequality’.”

The post also frames the pace of any “back to the office” momentum. 

“According to the Alliance for Downtown New York, which manages the area’s business district, just a quarter of workers in downtown Manhattan’s commercial offices are coming in at least part time. While that’s an improvement from just 10% in the depths of the pandemic, it’s a far cry from what it once was. Some companies, such as Goldman Sachs, are asking for their workers to come back full time, while others are opting for a hybrid model or are going fully remote. The future remains highly uncertain: Most remote work plans aren’t set in stone, especially as the pandemic continues to evolve.”

And cities have lost workers and residents. 

“Some researchers have identified a ‘donut effect’ of COVID-19 in cities, estimating that about 15% of residents and businesses have moved out of metropolitan hubs during the first year of the pandemic, many of them into the suburbs.”

Will we see a permanent hollowing out of city centres? And even if that hollowing out is just a few scoops (again, it may be hybrid with many workers back a few days a week), the future of cities and the economic effect might be permanent. 

But as that Vox post suggests, perhaps there is an easy fix? Retail workers can just follow the exodus and set up shop in the suburbs. 

On the investment front, perhaps what worked during the height of the stay-at-home economy will continue to thrive in the coming decade and more? In July of 2020, MoneySense columnist Jonathan Chevreau looked at those work at home ETFs. 

We will have to keep an eye on those office and mixed-use REITs as well. They will certainly have to learn how to pivot. 

For more on the subject and another great resource, here’s Marker on the death of downtown and the life of great American cities. 

Do earnings beats and misses really matter?

Morningstar asked: Do earnings beats and misses really matter? 

When we write about a company that beat or missed expectations, that means when the company reports actual earnings, it is measured against the estimates (the collective guesses) of analysts that cover the companies. We often read or report that a company missed on earnings or revenues. 

I often like to write that it’s not the company that missed—it’s the analyst that missed. 

It’s the real earnings that matter, not the estimates.

That Morningstar post offers… 

“Whereas short-term returns are driven by random factors, longer-term returns are driven by things that are more predictable, like dividend yield, earnings growth, and inflation. As explained in this interactive Morningstar Investing Classroom lesson, ‘The Purpose of a Company,’ over shorter periods of time, there can be a disconnect between how a company performs and how its stock performs. This is because a stock’s market price is a function of the market’s perception of the value of the future profits a company can create. Sometimes this perception is spot on; sometimes it is way off the mark.” 

Stock markets can be ridiculous. In the short term, they are reactionary and emotional. 

I like this quote from Benjamin Graham, the teacher of Warren Buffett who is thought to be the greatest investor of all-time:

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

Over time, the actual success of the companies will determine the returns. In the end, their earnings and business success will determine your success. Don’t be thrown off by analyst guesses or even a few quarters of real reports from the companies you hold. Remember why you own the company; ask yourself, is the rationale still intact? 

To bail on a company because of a few “bad” quarters is to guess about the future. We do not know if a company will fix any near term challenges. They might, they might not. I like to give them a chance. 

I invest with a blue-chip and quality slant. I recently reported on our U.S. stock portfolio. 

My Canadian stock approach is similar to the Beat the TSX Portfolio we offered up for consideration. 

It took me many decades to learn how not to touch my portfolio. Over the last several years I have not sold out of any stocks, even when many of them had a few rough patches. I have only trimmed here and there for rebalancing. In fact, instead of fearing a company that missed on earnings or revenues that did not live up to expectations, I embraced those companies as an investment opportunity. 

I often give some love (money) to the losers. For my U.S. stocks from 2014 and early 2015 (initial buys), I’ve seen the losers list diminish. Of 20 positions, only one stock (Walgreens) is in a negative position. That is a very good success rate. I have no idea what will happen with Walgreens. I’ll continue to practice buy-and-hold. Walgreens is on the list for new money when that account generates enough portfolio income to make a stock purchase. 

Now that I own the stocks, I look at earnings reports more out of interest. I will not react to any beats or misses. You might be different; you might be more active and have some shorter-term goals for certain stocks. 

To each their own. I am happy to have found a more passive and hands-off approach. You’ll find the Morningstar post reinforces many of the themes and practices I embrace. 

A new regulatory organization for Canada: Good news?

Canadian securities regulators are establishing a new self-regulatory organization that will oversee the country’s investment industry. This will potentially consolidate the functions of the two existing entities – the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA). 

IIROC oversees securities while the MFDA handles mutual funds and the investment sales force. 

The CSA also announced it would also combine two investor protection funds: the Canadian Investor Protection Fund and the MFDA Investor Protection Corporation. 

Hopefully there is good news for investors in these moves. Many typical investors who are advised are locked out of the benefit of low-cost ETFs and the all-in-one ETF portfolios that you’ll find in the MoneySense Best ETFs for 2021 guide. Why? Their advisors are often not allowed to offer these securities. 

From a Globe and Mail post (paywall)… 

“Currently, for example, mutual fund dealers cannot easily purchase ETFs for clients, because of the costs involved in integrating back-offices systems between dealers. As a result, mutual fund dealers often engage in complicated work-arounds, including referring a client to an IIROC dealer, or advising them to buy an investment fund that wraps ETFs. One of the solutions proposed by the CSA is to allow broker arrangements between mutual fund dealers and investment dealers, since they will all be regulated by a single body.”

We’ll see if this opens the door to more low-fee investing for the masses. That would be huge. 

That said, there might be many barriers and obstacles. Mutual fund dealers and managers like to “get paid” in generous fashion. That is the problem. 

The plan received positive reviews from industry advocates. I had a chat with Ken Kivenko, who is quoted in that post. He told me he is cautiously optimistic and that it could be a step in the right direction if applied in the best interests of investors. Kivenko likes the potential of what might happen on the regulatory front in terms of investor protection and awareness. 

Stay tuned. 

Dale Roberts is a proponent of low-fee investing who blogs at cutthecrapinvesting.com. Find him on Twitter @67Dodge.