MorningWord 6/14/16: I Have a Price, Therefore I am

by Dan June 14, 2016 9:57 am • Commentary

I don’t have too many go to sayings about markets and trading. There is one that I hear on the Finance Twitter a lot, Price is Truth. The assumption is that risk assets trade where it they should be at any given moment, given all available information to those buying and selling it. This another way of expressing efficient market hypothesis. And that speaks to the difficulty of actively managing performance that routinely beats the broad market.  From personal experience I can tell you that consistently beating the market is largely a function of the risk one is willing to take to achieve that goal. All profits are not created equal.

It’s been my view for some time that the risk/reward of committing fresh capital to equities globally is poor for a whole host of reasons (you can peruse those opinions here).

As far as the value of Price is Truth, 46% gaps in stocks like LinkedIn (LNKD) yesterday make you wonder if the saying has more value in existential philosophy than trading. Take-over news was not (and should not be) in the price of a stock prior to such an announcement.

LNKD 1yr chart from Bloomberg
LNKD 1yr chart from Bloomberg

While the premium paid for LNKD by MSFT is fantastical (about 100% from its 52 week lows made in February) remember, the purchase price remains 30% below its all time highs made in early 2015 and 25% below its 52 week highs made in late 2015.  The truth here for LNKD is that their decelerating revenue growth (sales that are expected to grow 25% in 2016 to $3.7 billion, but on growth that has decelerated from 35% in 2015, 45% in 2014 and 55% in 2013) and massive disparity between GAAP earnings and Adjusted (in 2015 LNKD “earned” $2.84 adjusted, on GAAP basis a loss of $1.29, or $373m in adjusted net income vs $163m GAAP loss) made a deal crucial for their management and board as adjusted losses have been mounting.

MSFT is paying all cash, but doing so in all debt to avoid paying taxes for repatriating their offshore cash. This deal is clearly a function of the global rate environment. MSFT is not earning anything on their $100 billion in cash. But they can borrow for nothing. And with no expected growth and a massive commitment to cash return the most innovative job at MSFT is being their crack financier, not a technologist.

Which brings me back to Price is Truth.

For people looking at the S&P 500 (SPX), down just 2.7% from its all time highs and thinking that’s some form of truth, look under the hood. The largest tech (and everything) component Apple (AAPL) is down 27% from its 52 week (and all time) highs. The largest energy component Exxon (XOM) is down 15% from its all time highs. The largest industrial competent General Electric (GE) is down 7% from its 52 week highs. The largest bank, JP Morgan (JPM) is down 10% from its 52 week highs. The largest automaker General Motors is down 20% from its 52 week highs. Lennar (LEN), the largest homebuilder, is down 18% from its 52 week highs. The biggest retailer WMT is down 5% from 52 week highs, but down 22% from its all time highs made in 2014. Disney (DIS), the largest media stock, is down 20% from its 52 week highs. Nike (NKE), the largest apparel seller, is down 20% from its 52 week and all time highs. Amgen (AMGN), the largest biotech, is down 15% from its 52 week and all time highs.

There are stocks that are doing well in 2016. The emergence from a death spiral for many energy and material stocks is a large part of the SPX’s recent bounce. As is the out-performance of defensive names in consumer staples like Proctor & Gamble (PG) and Johnson & Johnson (JNJ), big Pharma like Pfizer (PFE), U.S. Telcos like AT&T (T) & Verizon (VZ) and Utilities.

Sure the price of the SPX is just a few percentage points from its highs. But when you dive deeper into the internals,  it sure doesn’t feel like the truth.