With the 1Q19 earnings crush in full bloom, a lot of investors focused on nothing else. Developments that would ordinarily drive the market on their own ended up completely ignored until the overnight revelation that once again Chinese trade talks have hit a wall.
Yes, U.S. Gross Domestic Product grew 3.1% last quarter despite all the fretting that the season would actually deliver a slowdown instead. This doesn’t look like a recession at all, especially when you factor in robust hiring and the lowest unemployment rate in 50 years.
And yes, while the Federal Reserve saw zero reason to raise interest rates again last week, it wasn’t because the domestic landscape is getting treacherous. The Fed simply doesn’t see any real inflationary pressure to fight right now, and as long as global economic conditions remain volatile, our central bankers clearly think that it’s better to maintain a flexible posture in case something breaks overseas.
In the meantime, the U.S. economy can run as fast as it can. That’s a great feeling that a lot of investors haven’t gotten to enjoy in the last decade. We suspect that’s why the S&P 500 and other indices are once again breaking records even though earnings have hit a short-term wall, and why our stocks gained a respectable 1.5% last week.
Even so, earnings season has been good to us. The numbers stack up well. What we have is clearly not broken so there’s no reason to fix it.
There’s always a bull market here at The Bull Market Report! The Big Picture returns this week to update our math on why 1Q19 could be a growth quarter after all despite all the assumptions about a season of decline. And it’s time we weighed in on Tesla again, because we know many of you still like the company.
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Key Market Measures (Friday’s Close)
BMR Companies and Commentary
The Big Picture: A Growth Quarter After All
It wasn’t just a big week for BMR stocks. A full 32% of the S&P 500 crammed their quarterly numbers into the past five days, leaving a lot of investors struggling to simply weigh the results on a company-to-company basis. Once they get the chance to process the signal behind the noise, we suspect we’ll hear plenty of cheering.
After all, we’ve been saying for weeks now that the math points to zero real earnings deterioration in 1Q19. Expectations were simply too cautious and week after week, the results have added up fast enough that what initially looked like a 4% year-over-year decline will turn into a whisper of growth or, at the weakest, hold last year’s post-tax-cut high-water mark.
Now that a wider swathe of the market has reported, the statistics look stronger than ever. At this stage of the season, earnings have been good enough to erase 3.2% of what would have been the broad market’s earnings decline. Unless the companies that haven’t showed us their numbers are a whole lot weaker than the ones we’ve seen, we suspect we’ll end this cycle showing 0.1% growth across the S&P 500 as a whole.
Admittedly, that isn’t a thrilling score, but it’s a whole lot better than the cocktail of interest rates, tariff pressure and the longest federal government shutdown in history could have left us with. Even a crawl of positive movement like this is preferable to earnings moving the wrong direction. Richly valued stocks are still growing into their multiples. Undervalued ones get even more valuable. A market in record territory has fuel to justify continued upside.
And while that process isn’t playing out fast right now, investors love to anticipate longer trends. In the collective, Corporate America is a battleship that takes months to change direction. If this is as slow as the ship gets, then next quarter can show us a little more substantial growth as the economy accelerates.
Interest rates aren’t going up any time soon. Tariffs are already built into corporate strategy. The government is paying people again. With Gross Domestic Product growth ramping up beyond 3%, the economy here in 2Q19 looks healthier than it did last quarter, so earnings are poised to rebound with it.
Here’s where this math gets fun. Sector by sector, the numbers have been good enough to prove that earnings throughout the market avoided a full-fledged stall last quarter, but not every sector contributed the same amount to keep upside momentum alive. We’re overweight Technology so naturally need to know how much fire is keeping those stocks moving.
A month ago, it looked like the sector as a whole was going to report earnings 10% below last year’s level, thanks largely to Apple making the transition from Smartphone giant to Service provider. But Apple casts a very wide shadow across the numbers. Factoring its performance out, Technology is actually on track to squeeze a little growth out of the quarter after all.
Even Apple did better than expected, reducing the overall shadow it casts on the math. If, like us, you consider Alphabet, Facebook and Amazon to be “Technology” companies no matter where the formal sector boundaries are, it wasn’t a negative quarter at all.
That’s a huge thing. We suspect it’s why Technology is rallying despite questions around the companies at the top. Of course it’s also a question of relative scale: The biggest stocks can be a huge drag on the sector when they slow down, leading a lot of investors to overlook astounding performance from smaller counterparts like the ones we spotlight in our Research Reports.
And not all giants were created equal. Amazon is on track to grow at least 35% this year, more than cancelling out Apple’s temporary bout of weakness. All in all, this is still a great time to be a Technology investor. This is where the action is.
Don’t rule Apple out, either. We definitely aren’t. CEO Tim Cook is at least as gifted an accountant as he is a technologist, so he knows that money can make its own outcomes if it’s deployed right. Should he tap even half of his $225 billion reserves, he can buy back 600 million Apple shares and the same pool of profit will need to split fewer ways.
He can engineer up to 7% earnings growth any time he chooses. Right now, however, there’s no need to spend more than $75 billion this year to keep the numbers in his sweet spot while the next wave of iPhones moves toward the global market. (And the company is producing approximately $10 billion a quarter in cash.) Again, it only takes a thin pulse of growth to motivate investors to hold your stock long enough for the wind to change . . . and even buy a little more, knowing that a year from now there will be more profit to justify the same multiples.
The future still looks bright. Every day that passes takes us closer to the next boom.
Tesla (TSLA: $255, up 3%)
It’s clear that Elon Musk has a long-term plan to be the dominant player in the self-driving car market. He’s aiming to do that by being the best as opposed to first to the market. Even though competitors like Waymo and Uber seem to be leading the race to land a fully autonomous car on the road, Tesla has logged way more self-driven miles than anyone else.
Musk understands that when it comes to autonomous vehicles, experience (and therefore a better operating system) will be the differentiator. He’s already first on the road and his systems are learning with every human-steered Tesla driving around today. Let others reach the market first and make their mistakes in public.
Musk sees Tesla’s current business model of electric vehicles and solar energy as only the “backstop” of the company’s value while self-driving systems will create a half-trillion-dollar company. (Market cap currently stands at just under $45 billion.) Granted, he’s made some outlandish predictions in the past; the thing is, they tend to come true.
This is the same guy who proved you can land a rocket back onto its launch pad. Tesla has faced its challenges getting its first mass-market model delivered at the right price point, and the upcoming $2.7 billion stock sale buys Musk another year to get everything right. He’s putting his money where his mouth is, underwriting $25 million of the offering personally. The capital raise is enough to keep the company alive for quite some time to come, raising their cash level to almost $5 billion.
BMR Take: You have to be a triple believer to invest in Tesla. You need faith that there’s an age of autonomous vehicles ahead, trust Tesla’s strategy of playing the long game as opposed to trying to rush to the market and most importantly you need to believe in Elon Musk. We check all three boxes, so even though the stock has had a rough four months, we’re comfortable riding Tesla into the sunset. Risky though? You bet.
NOTE: In our weekly paid subscription Newsletter, we do between 5 and 7 of these SnapShots, like Tesla, above, and as earnings season continues we provide in-depth updates on dozens of companies. Plus, we have the Weekly High Yield Investor, whereby we discuss the 17 stocks in our High Yield and REIT Portfolios.
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