Tech Giants Spook the Markets

From the Financial Times last week:

We were able to get into the phone because, in an odd way, all the controversy around the litigation stimulated a marketplace around the world…for people trying to figure out if they could break into [an] Apple 5C running iOS9 — and those details matter because that’s the phone that the terrorists left behind.

That’s FBI director, James Comey speaking about the FBI’s successful hack of a terrorist’s iPhone.

That’s the free market for you. You can’t beat it.

Sometimes the free market results in things you agree with (such as new technology and innovation). Sometimes it results in things you disagree with (such as helping governments hack into private property).

We personally don’t like it that the free market has helped the US government in this way. But that’s our problem, not the free markets’.

If only governments felt that way, and learned to accept that trying to regulate and suppress the free market only results in distortions. Distortions which usually lead to problems elsewhere.

Another term for distortions is ‘bubbles and busts’. More on that in a moment…

Earnings trouble hits the market

If my colleagues and I believe something is important, we’ll make no apology for telling you about it time and again.

If we believe you should know about a potentially imminent profitable stock opportunity, I don’t have a problem with bringing it to your attention for days on end.

And if we believe you should know about a potentially imminent disaster in the markets, I don’t have a problem with bringing that to your attention for days on end, either.

We do that with our sales promotions (the long videos and emails we’ll send you), and we do it with our editorial — such as here in Port Phillip Insider.

One of the things I’ve regularly warned you about is analysts’ expectations for US company earnings. I’ve warned you that actual reported company earnings continue to be far lower than forecast future earnings.

In fact, the gap between the current and future earnings has grown so much that profits would have to grow by an amount that the market hasn’t seen since it recovered after 2009.

Due to the regular focus I’ve given the following chart, you’ve no doubt seen it before. But if not, let me briefly explain what it shows:

Source: Bloomberg

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The white line to the left of the green line shows actual earnings for companies in the US S&P 500 index. You can see how the white line began to curve downwards from early 2015.

The white line to the right of the green line shows analysts’ forecasts for future company earnings.

You’ll notice that even though the trend for actual earnings is lower, analysts still believe earnings will be higher (much higher) next year.

The last time company earnings grew by such an amount was from 2011 to 2012. That was when central bank money printing and stimulus were still relatively new and more — for want of a better word — ‘exciting’.

But it’s all different now.

Central banks are still trying out new and ‘exciting’ things, such as negative interest rates. But the effect on the markets isn’t what it was.

Importantly, the earnings coming out of America’s biggest tech companies aren’t what they were either.

As the Financial Times reports today:

Alphabet shares saw their steepest fall immediately after an earnings report in four years, after first-quarter earnings missed Wall Street forecasts and Google ad prices tumbled.

The parent company of Google, YouTube and Nest logged a 17.3 per cent jump in total sales to $20.3bn. Excluding the costs of acquiring traffic, Alphabet reported sales of $16.5bn, below analyst estimates of $16.6bn.

Until recently, Alphabet Inc. [NASDAQ:GOOG] was known as Google. The company rebranded its corporate name to reflect the fact that the business was trying to be more than just the Google search engine and online advertising behemoth.

But that means nothing when a company misses analysts’ estimates. Last Friday, the company released its results after the official market close, but as US stocks trade for several hours beyond the close in ‘extended hours’ trading, investors had the chance to give their verdict.

It wasn’t good. The stock fell 7%.

But it wasn’t just Alphabet that took a hit. As Bloomberg reports:

Microsoft Corp.’s turnaround just took a step backward.

The software maker on Thursday reported third-quarter earnings that fell short of analysts’ estimates because of a higher tax rate and said sales in the current period will fall short of some projections, sending the shares down in extended trading. Chief Financial Officer Amy Hood said results are being hurt by weakness in one-time purchases of software, what Microsoft calls its transactional business.

Microsoft Inc’s [NASDAQ:MSFT] stock fell more than 5% in extended hours trading. You can see from the chart below just how much each stock slumped.

Microsoft is the white line, Alphabet is the yellow line:

Source: Bloomberg

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Arguably, you could say that the market overreacted to the news. Heck, should investors really sell down Alphabet stock by 7%, when earnings came in at US$16.6 billion rather than US$16.5 billion?

It seems petty. But, remember that the estimated number is a consensus of analysts’ estimates.

The reason the stock can sell off by so much after missing by so little is that many analysts may have expected earnings well in excess of the consensus number.

If they expected profits of US$17.5 billion, they won’t be happy that the stock only ‘just’ missed the consensus number.

Take Douglas Anmuth, analyst at JPMorgan. According to Bloomberg, Anmuth has a 12-month price target on Alphabet of US$968. It’s currently trading at US$723.15.

Would Alphabet’s near miss have impressed Anmuth? Maybe. Maybe not.

This is the thing to watch. How will the current earnings season effect analysts’ earnings estimates for the year ahead? The US stock market is still near a record high.

But if analysts start to reassess their earnings forecasts and price targets for individual stocks, it will undoubtedly have a major impact on stock prices and the earnings multiples that investors are prepared to pay.

I’ll be honest. The market has rallied much more in recent weeks than I expected. But that doesn’t mean the worst of the market’s troubles are over.

The earnings misses by these US giant corporations could be the beginning of a huge re-rating of Wall Street expectations. And that could mean trouble for stock prices across the board.


Ed note: The above article was originally published in Port Phillip Insider.

Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Markets and Money e-newsletter in 2005. He is the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service, Markets & Money.

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