To end the week, the market experienced a notable rotation out of Tech (particularly the mega-cap FAAMG* stocks) and into Financials and Energy. Recall that Tech is the market-leading sector this year (+19% YTD) while Financials and Energy have been two notable laggards relative to the S&P 500 (+4% and -13% YTD, respectively). The FAANG complex has seen some significant strength this year, though concerns have been raised about valuation, positioning extremes, and complex risk narratives. We wouldn’t worry too much about the weakness to end the week related to the sector rotation just described. The bull market is alive and well.
* Facebook, Amazon, Apple, Microsoft and Google. This moniker keeps changing. From FANG – which left out Apple, to FAANG, which had Netflix, to FAAMG. We like this the best. The market cap of these five stocks is $2.4 trillion, led by Apple at $780 billion (it was over $800 billion on Thursday). Amazon is at $470 billion, Google is at $665 billion and Facebook is sitting at $450 billion. Combined, the FAAMG stocks have added $660 billion in market value this year.
Friday was a wild day. Listen to this: the Dow was up 89 points to close at 21, 272, a new all-time high. But, the S&P was flat and the Nasdaq was hammered, down 1.8%. It was the Tech stocks, that did it. It started at about 11 AM – the sellers stepped up and sold and never quit until the close. We’re going to watch the futures as they open tonight (Sunday) at 6 PM eastern. We are hopeful things will be calm, but watch out for some fireworks Monday.
The cost to have lunch with Warren Buffett fell this year. Is that a sign of an impending bear market? Of course not – how silly people can be. Lunch went for $2,680,000, down from $3,460,000 last year. The new winner is anonymous. It’s amazing how much money he has, this Mr. Anonymous! The winner gets to bring seven friends to dine with Buffett, 86, at New York’s Smith & Wollensky Steakhouse. Proceeds benefit Glide, a San Francisco charity.
There is always a bull market here at The Bull Market Report! This week we highlight the following stocks: Apple, PayPal, Cloudera, Facebook, and Visa.
Highlights From The Past Week
Credit Card Defaults Surge Most Since Financial Crisis. In late April, after some disturbing monthly charge-off reports from major credit card vendors, per the latest data from the S&P/Experian Bankcard Default Index, as of March the default rate on US credit cards jumped to 3.3%, an increase of 13% from a year ago, and the highest default rate since 2013. The troubling deterioration prompted Moody's to warn investors about the steep increase in credit card charge-off rates in 1Q17 and 4Q16 that were the largest since 2009. The size of the jump was particularly surprising considering the ongoing strength of the US employment market.
Oil Price Drought Lingers On. With crude (and gasoline) prices doing nothing but tumble since OPEC announced that it was extending the production cutbacks, erasing all the hope-fueled bounce off cycle lows, the question once again becomes, is $50 oil still realistic? Oil prices have plunged back to levels not seen since OPEC announced its original production cut deal last November. The underlying factors for the price drop are the same as before: U.S. shale production continues to rise; inventories remain elevated; and the markets are concerned that the OPEC cuts are not doing enough to drain the surplus. But, in fact, the outlook has grown a bit darker more recently, as downside risks to the market have grown. Note that for the 21st week in a row, US rig count is up.
Household Wealth Has Never Been Higher Relative To Income. For 45 years - until roughly 1994 - the average wealth-to-income of American households had held steady around 4.9x. Then the stock bubbles started, first under Greenspan, then Bernanke, and now Yellen, and as a result, as of 1Q17 for the first time in US history, household wealth reached a point where it is over 6.6x larger than household disposable income in America. The surge in wealth, driven almost entirely by new all-time highs in the S&P, has pushed this measure of rational exuberance (think of it as the country's price-to-earnings ratio), above the housing boom peak of the mid-2000s and well above the dot-com bubble-driven highs of the late 1990s.
BMR Companies & Commentary
Apple (AAPL: $149, -4%. Note that all prices in the newsletter are for the week)
Founded in 1976 by Steve Jobs and Steve Wozniak, Apple began as a personal computer vendor. Today, Apple enjoys a more diverse portfolio with the iPhone, iPad, Mac, Apple TV, Apple Watch and iPod, combined with a growing service and software offering that includes Apple Pay, iTunes, Apple Music, CarPlay, iCloud, iBooks, the App Store and more.
Apple's quarterly results will be less important this summer as investors are focused on the iPhone 8 this fall, along with the potential for increased dividend payments, P/E multiple expansion, and new innovations as showcased at Worldwide Developers Conference this week.
On Monday, Apple's innovation engine was in full force at WWDC with a plethora of software and hardware announcements that further expanded the depth and breadth of “Planet Apple”. This included the introduction of a new product category called HomePod, combined with important augmented and virtual reality announcements.
The star of WWDC was HomePod, which Apple believes will “reinvent home music” and will be a “go to” gift this holiday season. It is designed to fight it out with Amazon’s Echo – Alexa (which we have at home and love.) The HomePod will be available just in time for the holidays. As part of the iOS 11 announcement, Apple unveiled ARKit that allows developers to create apps that will enable users to place virtual content over real-world scenes. Apple believes it will create the “largest augmented reality platform in the world” given the hundreds of millions of iPads and iPhones in the market. Also, Apple announced that virtual reality support for content creation will be coming to the Mac for the first time.
BMR Take: We can’t say it enough about this company. Apple remains among the most underappreciated stocks in the world. The stock trades at 9x this year’s consensus EPS estimate of $9, and sits there with over $255 billion of cash.
PayPal (PYPL: $54, flat)
PayPal Holdings provides a leading technology platform company that enables digital and mobile payments on behalf of consumers and merchants worldwide. PayPal’s Payments Platform offers a wide range of products, including PayPal, PayPal Credit, Venmo, Braintree, Paydiant, and Xoom.
The stock has steadily appreciated since the 1Q17 earnings announcement in April. Why? Fears about take-rate* deceleration have diminished, among other things. Qualms over the Apple Cash announcement and impending Zelle** launch have faded. Instead investors have re-focused on fundamental usage trends. We expect consistent performance in operating metrics in the quarters ahead will bolster the cause.
* take-rate is the % collected per transaction.
** Bank of America is launching a person to person payments platform called Zelle.
Instead investors have re-focused on fundamental usage trends. We expect consistent performance in operating metrics in the quarters ahead will bolster the cause.
Payments is obviously not just about the transaction. There is a lot that goes into the user interface, risk decision, merchant- and consumer-side protection and services, and easy onboarding. All these factors build platform relevance, which in turn supports ongoing robust growth.
BMR Take: We continue to view PayPal as the way to invest in the digital commerce trend. The stock is compelling, trading at 25x next year’s consensus EPS of $2.12, versus long-term EPS growth prospects of 20%. Don’t forget about the $9 billion of cash with no debt.
Cloudera (CLDR: $19.40, -15%)
Cloudera is a developer of a data management and analytics platform designed to turn data into real business value. The company's Enterprise Data Hub is a secure and flexible big data software program that offers data engineering, real-time insights for modern data-driven businesses, all within this single, easy-to-use product, enabling businesses to access untapped opportunities currently hidden within their data which allows them to gain value from both data at rest and data in motion and to explore data in deeper context.
A subscriber wrote in to us and said that it wasn’t clear that we were adding Cloudera to the portfolio. We’ll he was right. We didn’t actually say that. But we should have. So yes, we are adding Cloudera to our Special Opportunities Portfolio.
Cloudera reported a solid first quarter. We will walk through what happened Friday as the stock was down hard. We are buyers on the weakness.
The company reported strong 1QF18 results this week – its first quarter as a public company. EPS came in at -27 cents, beating consensus of -36 cents on revenue of $80 million, beating the consensus of $76 million. Sales were fueled by impressive subscription revenue growth of 60%. Moreover, the net expansion rate* remained best-in-class at 140%, cash flow from operations was a pleasant surprise at $5 million, versus consensus of -$15 million, and the company guided well for future quarters this year.
* How much sales did you have ffrom a customer this year? How much last year? 140% means your old customers are growing their revenue nearly 2.5x over how much business they did with you a year ago.
Total revenue in the quarter was $80 million, an increase of 41% from the first quarter fiscal 2017. Subscription revenue was $65 million, an increase of 60% from the year-ago period. Subscription revenue represented 81% of total revenue, up from 72% in first quarter fiscal 2017.
"We had a strong first quarter as a public company, making progress against many of our key objectives," said Tom Reilly, CEO.
Loss from operations for the quarter was $30 million, compared to a loss from operations of $37 million in the year-ago period. Operating cash flow for the quarter was +$5.0 million compared to operating cash flow of negative $24 million in the first quarter of fiscal 2017.
After brushing against the all-time high on Thursday, the stock traded down 15% Friday due to billings that came in below consensus expectations. Management does not consider billings to be an accurate proxy for its business. We note that the company was satisfied with the performance of its sales team.
BMR Take: We think management has credibility on the outlook and just can’t view the stock’s sell-off as anything other than a major over-reaction. Stepping back from the quarter details, our thesis on Cloudera remains unchanged - we like its huge top-line growth (60%), enterprise focus, subscription-based model, large addressable market opportunity, solid gross margins, and opportunities for operating leverage. The stock looks compelling now trading at 4x the 2020 consensus revenue forecast of $540 million (which is nearly double this year’s revenue target).
Facebook (FB: $149, down 3%)
Facebook is focused on building products that enable people to connect and share, through mobile devices, personal computers and other surfaces. The company's products include Facebook, Instagram, Messenger, WhatsApp and Oculus. Facebook enables people to connect, share, discover and communicate with each other on mobile devices and personal computers.
The door is open for Facebook to knock the cover off the ball in the second half of this year. We expect ad revenue growth outperformance. Let’s re-visit why.
Facebook will be able to drive long term revenue growth without a material lift in ad load volume as the rollout of Instagram, Premium Video, and Dynamic Ads* will increase the amount Facebook can charge to advertise.
* From the Facebook website: Facebook dynamic ads automatically promote products to people who have expressed interest on your website, in your app or elsewhere on the internet. Simply upload your product catalog and set up your campaign one time, and it will continue working for you — finding the right people for each product - for as long as you want, and always using up-to-date pricing and availability. [Wow. One more reason for us to love this company. And stock.]
Street models are too conservative and underestimate the long-term monetization potential of upcoming new products. So we see optionality and upward bias to estimates, which do not contemplate contributions from multiple other products including Messenger and WhatsApp.
There was a change in ad impressions and pricing growth which came in this most recent quarter at +32% on impressions and +14% on pricing (versus prior quarters' range of +50% on impressions and 6% on pricing. The company took steps to prioritize longer form video content higher up in the newsfeed. Hence, this opens the door for pricing growth to accelerate further in 2H17 when Facebook takes more deliberate steps to moderate ad load – and presumably ad impression growth.
BMR Take: We believe Facebook can continue to dominate advertising. The stock's valuation has room to the upside as it is trading at 28x the consensus EPS outlook for this year of $5.42 despite the massive long term growth prospects. EPS is expected to double by 2020. Stick around!
Visa (V: $95, -2%)
Visa is a global payments technology company that connects consumers, businesses, financial institutions, and governments in more than 200 countries and territories to fast, secure and reliable electronic payments. Visa operates one of the world’s most advanced processing networks — VisaNet — that is capable of handling more than 65,000 transaction messages a second, while offering fraud protection for consumers and assured payment for merchants.
What’s new at this blue chip? Visa recently added 13 new token service providers to broaden global access to Visa Token Service. What? Let us tell you why this is so cool and important.
Visa announced it has signed 13 new partners to participate in its token service provider (TSP) program, as the payments industry shifts from plastic to digital and broader access to new standards, such as tokenization*, are needed. With demand expected to increase for payments to be embedded into a growing number of devices, services and experiences, Visa has built out a global network of partners to offer secure, digital payment token services and ensure that regardless of form factor, an Internet-of-Things (IoT) device, appliance, wearable or beyond, can become a more secure place for commerce.
* Tokenization, when applied to data security, is the process of substituting a sensitive data element with a non-sensitive equivalent, referred to as a token, that has no extrinsic or exploitable meaning or value. In other words, when you swipe your Visa card at the Starbucks counter, your debit/credit card information gets tokenized. So if it gets stolen later on, it is just a random number and not your actual bank info.
IoT is a monster trend. Billions of devices in the next several decades are going to end up being connected to the internet. Your refrigerator. Cars. Tractors. And anything you can think of. Why not? Hence the name—Internet of Things.
By Visa getting in now with tokenization, the company will be able to process payments on all these devices. Money, money, money! The growth we see at Visa is going to continue.
Don’t just take it from just us. Jim McCarthy, executive vice president, innovation and strategic partnerships at Visa said: “A potential tidal wave of new payment accounts is approaching — conservative estimates expect 21 billion Internet-connected devices in just three more years, so having both the partner network and the right technology in place are fundamental to driving payments on those devices.”
BMR Take: Visa defines the word blue chip. Do you remember how much Visa is worth now? $220 billion. Unreal big. And getting bigger. The stock trades at 24x next year’s consensus EPS estimate of $3.94 with EPS growth running at 15-20%. And it will stay that way for a long time with the IoT mega-trend coming online in the next few years. Plenty of growth ahead for this cash machine. Speaking of cash, they have $8 billion, with $16 billion of debt. A good ratio.
Upcoming Economic News
Producer Price Index ex-Food & Energy Y/Y
Tuesday, 8:30 AM
Period: MAY
Actual: N/A
Consensus: 2.0%
Prior: 1.9%
The Producer Price Index (PPI) is for all items less food and energy, often referred to as Core PPI.
Consumer Price Index ex-Food & Energy Y/Y
Wednesday, 8:30 AM
Period: MAY
Actual: N/A
Consensus: 1.9%
Prior: 1.9%
The Consumer Price Index for all items less food and energy, often referred to as Core CPI, excludes the two most volatile components of the overall CPI.
Industrial Production M/M
Thursday, 9:15 AM
Period: MAY
Actual: N/A
Consensus: 0.20%
Prior: 0.98%
This includes data measuring output in the industrial sector, which the Federal Reserve defines as manufacturing, mining, and electric and gas utilities.
Housing Starts
Friday, 8:30 AM
Period: MAY
Actual: N/A
Consensus: 1,225,000
Prior: 1,172,000
The number of housing units started in the United States. The U.S. Census Bureau's New Residential Construction release provides statistics on the construction of new privately-owned residential structures in the United States.
Some Thoughts on Splunk (SPLK: $58, down 7%)
Growing Pains Emerge in Q1, but the Opportunity Remains. Splunk billings grew 30% YoY, beating consensus expectations by a solid 6% in FY1Q18. The Americas region showed strong execution despite a recent sales reorganization, but European execution faltered, necessitating a change in sales leadership in the region. We see Q1 more as evidence of near-term growing pains as the company puts into place a distribution channel capable of efficiently taking revenues to the $2 billion FY20 target.
Total billings of $240 million grew 30% YoY, a deceleration from 35% in Q4, but still 6% ahead of consensus. Total revenues at $242 million also sustained 30% YoY growth, despite a growing contribution from subscription based Cloud business pushing license growth down to +16% YoY in the quarter versus
35% in Q4. Splunk added 500 new customers in the quarter, in-line with the 500 added in each Q1-Q3 FY17.
FY18 Outlook Moves Modestly Higher. Despite European execution issues, management expressed confidence in the fundamental demand environment (and Splunk's ability to accrue that demand) via an increase to full year top line targets. The revenue guidance moves up modestly from $1.18 billion to $1.19 billion. Further, the company remains committed to expanded sales capacity in line with last year's increase, as the company remains capacity constrained versus opportunity constrained.
Large Deal Growth Slows. Splunk signed 360 deals over $100K in value, up 13% YoY, however this represents a deceleration vs. the 34% growth in large deals seen thru FY17 and 33% growth in Q4. The company saw 80% of business derived from existing customers in the quarter. We don’t really think getting 80% of its revenue from existing clients is a bad thing. In fact, that means 20% came from new business. We’ll buy that logic.
Q2 Guidance Brackets Consensus, FY18 Top Line Guidance Moves Higher. Management is looking for 2Q18 revenue of $268 million and operating margins of 4%.
BMR Take: We like this company; we like the numbers they are doing; we are long term investors at this price level.
SNAP (SNAP: $18.08, down 14%)
Snap, owner of Snapchat, had a rough week. We don’t like this one here at The Bull Market Report and we want to make you aware of why. We just think they are losing too much money and their user numbers are slowing. They are the most shorted Tech IPO out there, with a 28% short interest. Now some, including us, say that a large short position is bullish. Well, yes and no. It is bullish because those shares have to be bought back at some point. But it is bearish because many of the smartest minds on Wall St. think it is going lower. We’re in the latter camp this time.
Some negatives –
User growth is slowing.
Citigroup downgraded the stock.
CEO Evan Spiegel got a $750 million bonus for taking Snap public.
They lost $200 million in the 1st quarter of 2017. That’s a lot of dough.
BMR Take: Some say this is the next Facebook, so that’s the positive angle and this cannot be discounted – there is a lot of money riding on this company succeeding. We just don’t want to be playing this game at this time. A year or two from now? Maybe. We’re happy to watch and wait patiently on the sidelines.
Apple Corner
There was a rumor that the new Apple 8 can’t handle the new, faster data speeds that are coming down the pike. Well, let us say this. First of all, Apple doesn’t comment on new products that haven’t been announced, so there is no way we can know if this is true. Secondly, the new data speeds of the internet are years away. And guess what? Apple will have new software to handle the bigger speeds, AND they will have the Apple 9 out by then. So we say: Bunk.
Apple (AAPL: $149) had a bad day Friday, down $6 from $155, and after flirting with its all-time high of $156.65, set May 15th. We’re really not too concerned about this one-day, 3% drop. Nothing has changed really – just the perception that the Tech stocks can go down from time to time. But we already knew that. Stocks are inherently risky, but we’d rather take the risk of owning an Apple, as we are up 54% from the date we added it 16 months ago. And all the while the 10-year Treasury note is paying a little over 2% a year. Take your pick.
Tesla (TSLA: $357) Update
Pacific Crest, a Wall Street research firm, put a new price target on Tesla of $439. Wahoo! The stock hit an all-time high Friday of $377 and then got hammered down to $357, finishing the week up $17 or 5%. Our Target was $350 which we raised just a week or two ago. We actually think the stock can go a lot higher, as the future of the company is ahead of it, especially as they get closer to delivering cars in massive quantities later this year and next. But what if what happened Friday is indeed the beginning of the end for Tech stocks, including Tesla?
BMR Take: Let’s do this. If the stock gets hammered Monday and Tuesday and falls below $350, let’s get out, take a breather and watch what happens. After all, having added the stock at $199 17 months ago, we have had quite a run, now up 80%. We wouldn’t want to give up these gains.
The High Yield Corner
By Michael Foster
Before we start talking about high yield, we want to talk about oil.
Oil futures have not been doing well. If you’re a futures trader, you’re probably laughing at the absurd understatement of that sentence. Crude oil futures slumped 4% this week after the steep drop on Wednesday, bringing it closer to its 52-week low of $44, which it reached in early May during another moment of energy volatility. Oil is now down about 20% year-to-date, leading to the somewhat rational question of whether 2017 proves to be the worst year for the commodity since the blood bath of 2014.
With oil prices tumbling, everyone is affected. Of course, the effect is quite different depending on where you are in the market and who your customer base is. The classic argument is that low oil is good for consumer discretionary stocks. If Americans are spending less at the pump, so the theory goes, they’ll have more money to spend buying all kinds of stuff they normally wouldn’t buy.
Simple theory. It sounds logical enough to be compelling, although it’s very wrong. The problem with the theory is that it doesn’t take into account things like income growth, ex-energy CPI trends, and labor participation rates. The macroeconomics are quite different now, so consumer discretionary may not be as unaffected by cheaper oil than in 2014, but the Consumer Discretionary SPDR (XLY: $91) is already up 12% for 2017, so it may be too late to play oil’s weakness this way—especially since other macroeconomic factors make the correlation not so 1-to-1.
Likewise, other sectors and entire asset classes get impacted by changes in oil. High yield is one of them. Back in 2014, high yield assets were hit pretty hard with the fall in oil; when oil prices got even worse in 2015, high yield assets were hit yet again. To make matters worse, the Federal Reserve was hinting at raising interest rates, which itself tends to be bad for high yield. All of this meant high yield funds like the SPDR High Yield Bond Fund (JNK: $37) had an awful run, and high yield was being rejected as an asset class by the broader market.
Now that oil is repeating its 2014-2015 decline and consumer discretionary is repeating its 2014 run-up, you would expect high yield to also repeat its historical weakness and be at best on the decline and at worst in a full-on bearish downtrend. But the SPDR fund and most high yield bond funds are up healthily for 2017. The SPDR fund is up 2% so far excluding its near 6% yield, and The Bull Market Report pick Pimco Dynamic Income Fund (PDI: $30) is up 8% for the year excluding its near 9% dividend (which doesn’t exclude special dividends, which last year brought the yield up to a whopping 14%). From the start of 2016, the Pimco fund is up over 9% excluding the $5.19 in dividend payouts since then (giving the fund a 19% total return over the period, well above the S&P’s 15% return over the same period).
That leads to the question of whether it’s time to sell, since you’d expect cheap oil and rising interest rates to be significant problems for bonds. Remember the Fed is widely expected to raise rates this week. Cheaper oil will cause poor performing energy companies to be insolvent and default on loans; higher interest rates will make it harder for existing firms to pay back their loans while also lowering the price in the market for corporate bonds. All of this is really, really bad for junk bond funds.
Again: So the simple theory goes. In reality many of these problems have been priced into junk bonds for a long time. The low and depressed prices of junk bonds in 2014-2015 helped create the bull market from 2016 to today. But it goes back even further than that. If you look at the SPDR High Yield fund’s price return from 2013 to 2015, you’ll see that every year saw the fund’s net asset value go down due to lower and lower demand for risky corporate bonds. Junk was really acting like junk.
Go back even further, and you’ll see that junk bonds stayed pretty much at the same price range from the end of 2009 to early 2015, which is actually 8% lower than today’s current price for high yield corporate bonds.
High yield debt isn’t supposed to act this way. These debts are supposed to go up in price during times of economic growth and go down very sharply in times of economic weakness and/or recession. But the U.S. since 2012 has been in a state of admittedly slow but steady improvement. Corporate bonds should be attracting more capital, not less.
Finally, starting last year, this began to happen in a noticeable way. But the bonds are still not priced where they should be relative to the business cycle. This means high yield bonds still have room to go up in value.
This isn’t just true of corporate bonds. In fact, something very similar has been happening to municipal bonds and REITs, which is why we have been aggressively recommending them for a long time. Sadly, there isn’t enough room this week to go into the details of why these asset classes are also well-positioned in this odd business cycle. But next week we’ll take a closer look at why both of these, like junk bonds, are deeply underappreciated in today’s market.
Good Investing,
Todd Shaver
Editor, Founder and CEO
The Bull Market Report
Since 1998
Disclosure: The Bull Market Report is a compilation of original writings, news from publicly available sources, and third-party research. The subscriber agreement acknowledges that The Bull Market Report is an information source to give you the background to invest in the stock market.