Since reporting calendar Q3 results in the last week or so, Apple (AAPL), Alphabet (GOOGL), Amazon.com (AMZN) and Facebook (FB), have lost between 5 and 10%. That is equal to nearly $200 billion in combined market capitalization. We can really stop here if you are trying to figure out what has weighed more on the broad market, Trump’s tightening Clinton’s lead in the polls, or the loss of market leadership from a highly concentrated group.
Last night on CNBC’s Fast Money, Carter Worth of Cornerstone Macro Research highlighted this concentration, showing that the top 5 stocks (AAPL, MSFT, GOOGL, AMZN & FB) in the S&P 500 (SPX) by market capitalization equal the weight of the combined bottom 250, about $2.5 trillion vs $2.5), watch here:
Carter’s call is for a re-test of the long term uptrend in the SPX, and his historical data suggests that when this top 5 to bottom 250 happens, the top 5 usually under-performs the SPX during the next 6 month period.
You’d be hard-pressed not to notice that the top 5 are all tech stocks. And it’s worth spending a few minutes on why (aside from MSFT, which has given back some of its post earnings gains) these stocks have dropped despite (all putting up monster Q3 results). To me it seems kind of obvious, CEOs like Jeff Bezos generally don’t care what Wall Street analysts and investors want from them on a near term basis (nor should they). As I stated yesterday in my FB earnings preview:
If there is another Founder/CEO, besides Jeff Bezos of Amazon, of any other mega cap tech company that could care less about Wall Street analyst consensus, or investors short term desires, it is Mark Zuckerberg. I would not be surprised, with the stock a few percent from all time highs to see the company offer conservative Q4 guidance no matter what they print for Q3.
Investors can justify growth at a reasonable price for GOOGL. It trades 20x expected 2017 eps growth of 18%, which would be the highest growth rate since 2011, on expected accelerating sales growth of 20%. On the flip side, AMZN investors have been conditioned to not value the stock on a P/E basis, but to focus on revenue growth that meaningfully accelerated in 2016 to expected 28% from 20% the prior two years, with EBITDA growth of 44% aided by the growth and margin profile of AWS and the creeping margins on retail.
AMZN is likely the one where investors shoot first and ask questions later with the stock up 72% from its 52 week lows made in February.
You get the theme. I’ve seen this before. Bezos & Zuck don’t care about ratcheting up spending, especially when they have the sort of revenue growth they have, and their vision for the future.
But recognizing the push and pull between sales growth, costs for maintaining it and effect on profitability from aggressive investing is something big money investors are keenly focused on when it comes to high growth, high valuation tech stocks. In the more than 25 years since Dan Benton, the former Goldman Sach’s Hardware analyst in the 1990s, (and massively successful hedge fund investor since) published his 20 rules for technology investing I find myself checking back in on them attempting to applying them to the current environment or specific stocks or sectors:
1. Sell technology stocks when estimates are being reduced.
2. Buy technology stocks only for positive earnings surprises.
3. Positive earnings surprises occur when revenue and earnings growth are accelerating, when average selling prices are rising, and when gross margin and operating margin are rising.
4. Most technology stock ideas are product-cycle stories.
5. New product cycles often lead to earnings surprises; product cycle transitions usually lead to earnings disappointments.
6. Technology stocks also do well when companies rebound from periods of poor execution.
7. Value investors don’t make money in technology. There are few “cheap” technology stocks.
8. Don’t buy on relative P/E, P/B, P/R, particularly when estimates are falling (see Rules 1 and 2).
9. Technology stocks perform poorly in the summer.
10. Seasonal slowdowns cause secular concerns.
11. Second-tier companies do poorest in the weakest seasonal period and provide anecdotal evidence of an industry slowdown.
12. Reorganizations without restructuring charges usually lead to earnings disappointments within two quarters.
13. One-quarter problems exist (but only if caused by supply constraints).
14. Management usually appears weakest at the bottom of a product cycle.
15. Insider selling doesn’t matter; management gets new stock options every year.
Old World/New World
16. Traditional mainframe and minicomputer companies are in secular decline.
17. It is increasingly difficult to differentiate companies that sell microprocessor-based computers.
18. Execution is the most important distinguishing factor in a standards-based world.
19. It is hard to forecast execution.
20. Don’t forget Rule 1.
Source: Goldman Sachs
As for Rule 1, we saw that in AAPL this past year. I think it is safe to say that increased spending as warned from AMZN & FB for 2017 might not translate into higher sales, but it tends to hurt profitability. At the very least we are starting to see deceleration in profit growth, if that was coupled with a decline in sales growth (see AAPL, which just had its first annual eps and sales decline since 2001 in fiscal 2016, down 10% and 8% respectively), then the broad market, most specifically the Nasdaq, from last week (Breadth Mints – QQQ).
At this point, barring a surprise Trump victory (which could be a Brexit type market reaction), I suspect the broad market is up or down a few percent from current levels. But if the guidance given from AAPL, AMZN & FB were to become a trend when they report Q4 results in late January, then you are gonna want to become very familiar with Benton’s rules for tech investing.
At this point it seems like a tough short to press, but the uptick in volatility might provide the opportunity to sell near dated puts to help finance longer dated ones targeting Feb expiration which should capture the bulk of Tech Q4 earnings.
*QQQ ($115) Buy the Nov/Feb 110 put calendar for 2.10
- Sell 1 Nov 110 put at .65
- Buy 1 Feb 110 put for 2.75
Rationale – This trade sells elevated implied volatility vol after the recent sell-off in tech leadership (and spike in VIX) to finance a February put. The most that can be lose in this trade is 2.10. The ideal situation is if the QQQ is at 110 but doesn’t collapse below that level before Nov expiration.
As we get closer to Nov expiration, if the QQQ is still banging around current levels, then we will look to cover the Nov 110 put which will have decayed meaningfully and then look to either turn into a calendar again by selling a Dec 110 put, or possibly turn into a vertical put spread by selling a lower strike put in February.
To my eye, the QQQ is at an important near term technical level at $115, with an air-pocket below to $110, which also happens to be the uptrend from the August 2015 flash crash lows.