The Evolving Late Stage Bull Market
Last week, James Mackintosh had an interesting article in the WSJ about the stealth bear market. His main point was that stocks have essentially gone nowhere since Jan 26, 2018. Digging a little deeper, he points out that the Russell Top 50 Mega Cap Index is up over 5% in that period while the Russell 2000 as a whole is down 3.6%. In other words, it’s the very large stocks that are now driving this thin market. If you look at the charts, the biggest 5 stocks (Facebook, Apple, Amazon, Google and Microsoft) are having monster years, but many stocks are not keeping pace.
Mackintosh followed up his article on the stealth bear market this week with one on WeWork and investors shift from seeking growth at all costs to profitability. WeWork’s massive losses caused the company to essentially blow up during the IPO process, going from a valuation of $47 billion to $8 billion. According to Mackintosh, that’s because investors are no longer willing to pay up for fast growing, money losing startups and instead are focusing more on profitability.
This analysis seems borne out by recent reactions to 3rd quarter earnings reports. Wednesday afternoon, stalwarts Apple and Facebook reported solid, profitable quarters and the market rewarded them, even though they are already up significantly this year. Apple’s numbers were essentially flat, but that is good enough for a company whose business model is evolving away from complete dependence on a saturated smart phone market and towards wearables and services. Facebook’s revenue was up 29% and operating income 24%. Tesla’s stock operates according to different dynamics but it got an enormous boost when it reported a surprisingly profitable quarter despite an 8% decline in revenues.
On the other hand, Amazon struggled a bit as 1 day fulfillment added to retail costs and competition from Microsoft and others slowed AWS operating income growth to 9%. Similarly, Google reported strong top line growth of 20%, but increasing expenses hit profitability and caused a slight selloff in the stock.
More broadly, money losing recent IPOs have not fared well. Uber and Lyft are the most obvious examples. Both are trying to grow market share at the expense of current profitability and the market isn’t having it.
All this suggests that investors are aware that the bull market is in the later stages and are looking forward to the end of easy financing. If these companies can’t finance themselves through venture capital or bond offerings, their lack of profitability makes it impossible for them to finance themselves internally. The recent outperformance of value also supports this interpretation.
The food delivery space offers a vivid illustration of this dynamic. Grubhub reported 3rd quarter earnings on Monday afternoon and 4th quarter guidance showed that competition is heating up. Investors were caught off guard sending shares down 43% on Tuesday. The reason is that private DoorDash and Uber Eats have enormous war chests that are enabling them to operate at a loss in an attempt to gain market share. This is destroying profitability for the whole industry as Grubhub’s results showed. “We now view this as a race to the bottom with no clear winners” analyst Robert Mollins told the WSJ.
Trends evolve and the shift away from growth at all costs to profitability and the thin mega cap market leadership may not persist. However, in my estimation, these new wrinkles suggest that investors are concerned that the bull market is entering it’s end stages and are positioning accordingly. After 10 1/2 years of a relentless bull market, many are still scared of missing out (FOMO), however you can’t catch the very top and these shifts suggest to me that much of the smart money is shifting its positioning. We may be in the kind of market where you have to pick up pennies in front of a steamroller, as Mark Minervini is fond of saying, as opposed to the long uptrending bull market we experienced from March 2009 through January 2018.
Founder & CEO
Top Gun Financial (www.topgunfp.com)
A Registered Investment Advisor