Tag Archives: Apple

Will The Corona Virus Trigger A Recession?

As if waking up to an economic nightmare, investors see headlines like these and many others flashing across their Bloomberg terminals:

  • Facebook says Oculus headphone production will be delayed due to virus
  • Apple extends country wide store closing for another week
  • Foxconn delays iPhone production
  • Qualcomm cuts production forecast due to virus uncertainty
  • Starbucks announces China store closures through Lunar New Year, uncertain when they may reopen
  • US Steel flashes a warning of a cut in demand
  • Nike shoe production halted
  • Under Armour missed on sales, and their outlook is weak. They partially blamed the Corona Virus outbreak.
  • IEA forecasts drop in oil demand this quarter- first time in a decade

The seemingly never ending list of delays, disruptions, and cuts rolls on from retail to high technology. Even services are impacted as flights and train trips are canceled within and to and from China.  While some technology-based services are provided over the Internet service, restaurants, training, and consulting, as examples, must be performed in person.  Manufacturing operations require workers to be at the factory to produce products. Thus, manufacturing is much more acutely affected by quarantines, shutdowns, transportation disruption, and other government actions.

It is as if an economic tsunami is rolling over the global economy. China’s economy was 18 % of world GDP in 2019.  For most S & P 100 corporations, the Asian giant is their fastest growing market at 20 – 30 % per year.  Even more critical, China has become the hub of world manufacturing after entering the World Trade Organization in 2000. Over the past two decades, U.S. corporations have relocated manufacturing to China to leverage an inexpensive labor force and modern business infrastructure.

Source: The Wall Street Journal – 2/7/20

Prior to the epidemic, world trade had begun to slow as a result of the China – U.S. trade war and other tariffs.  World trade for the first time since the last recession has turned negative.

Source: Haver Analytics, The Wall Street Journal, The Daily Shot – 1/19/20

Based on severity estimates, analysts have forecasted the impact on first-quarter China GDP growth. In the chart below from Fitch Ratings, growth for first quarter drops almost in half and for year growth drops to 5.2 % if containment is delayed:

Sources: The Wall Street Journal, The Daily Shot – 2/6/20

When news of the virus first was announced, the market sustained a quick modest decline. The next day, investors were reassured by official news from China and the World Health Organization that the virus could be contained. Market valuations bounced on optimism that the world economy would see little to no damage in the first quarter of 2020.  Yet, there is growing skepticism that the official tolls of the virus are short of reality. Doctors report that at the epicenter of Wuhan that officials are grossly underestimating the number of people infected and dead. The London School of Hygiene and Tropical Medicine has an epidemic model indicating there will be at least 500,000 infections at the peak in a few weeks far greater than the present 45,000 officially reported.

The reaction, and not statements, of major governments to the epidemic hint that the insider information they have received is far worse and uncertain.  U.S. global airlines have canceled flights to China until mid-March and 30 other carriers have suspended flights indefinitely – severely reducing business and tourist activities.  The U.S. government has urged U.S. citizens to leave the country, flown embassy staff and families back to the U.S., and elevated the alert status of China to ‘Do Not Travel’ on par with Syria and North Korea. All of these actions have angered the Chinese government. While protecting U.S. citizens from the illness it adds stress to an already tense trade relationship. To reduce trade tension, China announced a relaxation of import tariffs on $75 billion of U.S. goods, reducing tariffs by 5 to 10 %.  President Xi on a telephone call with President Trump committed to complete all purchases of U.S. goods on target by the end of the year while delaying shipments temporarily.  It remains to be seen if uncontrolled events will drive a deeper trade wage between the U.S. and China.

Inside China, chaos in the supply chain operations is creating great uncertainty. Workers are being told to work from home and stay away from factories for at least for another week beyond the Lunar New Year and now well into late-February.  Foxconn and Tesla announced plant openings on February 10th, yet ramping up output is still an issue. It will be a challenge to staff factories as many workers are in quarantined cities and train schedules have been curtailed or canceled.  Many factories are dependent on parts from other cities around the country that may have more severe restrictions on transportation and/or workers reporting to work. Thus, even when a plant is open, it is likely to be operating at limited capacity.

On February 7th, the Federal Reserve announced that while the trade war pause has improved the global economy, it cautioned that the coronavirus posed a ‘new threat to the world economy.’  The Fed is monitoring the situation. The central bank of China infused CNY 2 trillion in the last four weeks to provide fresh liquidity.  The liquidity will help financially stretched Chinese companies survive for a while, but they are unlikely to be able to continue operations unless production and sales return to pre epidemic levels quickly.

Will the Federal Reserve really be able to buffer the supply chain disruption and sales declines in the first quarter of 2020?  The Fed already seems overwhelmed, keeping a $1+ trillion yearly federal deficit under control and providing billions in repo financing to banks and hedge funds causing soaring prices in risk assets. While the Fed may be able to assist U.S. corporations with liquidity through a tough stretch of declining sales and supply chain disruptions, it cannot create sales or build products.

Prior to the virus crisis, CEO Confidence was at a ten year low.  Then, CEO confidence levels improved a little with the Phase One trade deal driving brighter business prospects for the coming year. Now, a possible black swan epidemic has entered the world economic stage creating extreme levels of sales and operational uncertainty.  Marc Benioff, CEO of Salesforce, expresses the anxiety many CEOs feel about trade:

 “Because that issue (trade) is on the table, then everybody has a question mark around in some part of their business,” he said. “I mean, we’re in this strange economic time, we all know that.”

Adding to the uncertainty is a deteriorating political environment in China.  During the first few weeks of December, local Wuhan officials denounced a doctor that was calling for recognition of the new virus. He later died of the disease, triggering a social media uproar over the circumstances of his treatment. Many Chinese people have posted on social media strident criticisms of the delayed government response.  Academics have posted petitions for freedom of speech, laying the blame on government censors for making the virus outbreak worse.  The wave of freedom calls is rising as Hong Kong protester’s messages seem to be spreading to the mainland. The calls for freedom of speech and democracy are posing a major challenge to President Xi.  Food prices skyrocketed by 20 % in January with pork prices rising 116 % adding to consumer concerns. Political observers see this challenge to government policies on par with the Tiananmen Square protests in 1989. The ensuing massacre of protestors is still in the minds of many mainland people. As seems to be true of many of these events that it is not the crisis itself, but the reaction and ensuing waves of social disorder which drive a major economic impact.

Oxford Economics has forecast a slowdown in US GDP growth in the first quarter of 2020 to just .6 %

Sources: Oxford Economics, The Wall Street Journal, The Daily Shot – 2/6/20

Will U.S. GDP growth really be shaved by just .4 %?  If we consider the compounding effect of the epidemic to disrupt both demand and supply, the social chaos in China challenging government authority (i.e., Hong Kong), and a lingering trade war – these factors all make a decline into a recession a real and growing possibility.  We hope the epidemic can be contained quickly and lives saved with a return to a more certain world economy.  Yet, 1930s historical records show rising world nationalism, trade wars, and the fracturing of the world order does not bode well for a positive outcome. Mohammed A. El-Arian. Chief Economic Advisor at Allianz in a recent Bloomberg opinion warns of a U shaped recession or worse an L :

I worry that many analysts do not fully appreciate the notable differences between financial and economic sudden stops. Rather than confidently declare a V, economic modelers need more time and evidence to assess the impact on the Chinese economy and the related spillovers – a consideration that is made even more important by two observations. First, the Chinese economy was already in an unusually fragile situation because of the impact of trade tensions with the U.S. Second, it has been navigating a tricky economic development transition that has snared many countries before China in the “middle income trap. All this suggests it is too early to treat the economic effects of the coronavirus on China and the global economy as easily containable, temporary and quickly reversible. Instead, analysts and modelers should respect the degree of uncertainty in play, including the inconvenient realization that the possibility of a U or, worse, an L for 2020 is still too high for comfort.”

Patrick Hill is the Editor of The Progressive Ensign, writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like HP, Genentech, Verigy, Informatica, and Okta to provide investment and economic insights. Twitter: @PatrickHill1677.

Quick Take: The Great “Tesla” Hysteria Of 2020

“Let us see how high we can fly before the sun melts the wax in our wings.” – E. O. Wilson

Since January 1, 2020, Tesla’s (TSLA) stock price has risen by $462 or 110%. TSLA’s market cap now exceeds every automaker except for Toyota. In fact, it exceeds not only the combined value of the “big three” automakers GM, Ford, and Chrysler/Fiat, but also companies like Charles Schwab, Target, Deere, Eli Lily, and Marriot to name a few large companies.

Seem crazy? Not as crazy as what comes next. Crazy are the expectations of Catherine Wood of ARK Invest. This well-known “disruptive innovation” based investor put out the following chart showing an expected price of $7,000 in 2024 with a $15,000 upside target.

Siren songs such as the one shown above encourage investors to chase the stock higher with reckless abandon, and maybe that is ARK’s intent. Given their large holding of TSLA, it certainly makes more sense than their price targets. Instead of taking her recommendations with blind faith, here are some statistics to illustrate what is required for TSLA to reach such lofty goals.

To start, let’s compare TSLA to their peer group, the auto industry. The chart below shows that TSLA has the second largest market cap in the auto industry, only behind Toyota. Despite the market cap, its sales are the lowest in the industry and by a lot. According to figures published on their website, TSLA sold 367,500 cars in 2019. General Motors sold 2.9 million and Ford sold 2.4 million.

Clearly investors are betting on the future, so let’s put ARK’s forecast into context.  

If the TSLA share price were to rise to their baseline forecast of 7,000, the market cap would increase to $1.26 trillion. Currently, the auto industry, as shown above, and including TSLA, aggregates to $772 billion. At the upside scenario of 15,000, the market cap of TSLA ($2.7 trillion) would be almost four times the current market cap of the entire auto industry.  More stunning, it would be greater than the combined value of Apple and Microsoft.

Even if we make the ridiculous assumption that TSLA will be the world’s only automaker, a price of 15,000 still implies a valuation that is three to four times the current industry average based on price to sales and price to earnings. At 7,000, its valuation would be 1.6 times the industry average. Again, and we stress, that is if TSLA is the world’s only automaker.

Summary

Tesla is one of a few poster children for the latest surge in the current bull market. That said, it’s worth remembering some examples from the past. For instance, Qualcomm (QCOM) was a poster child for the tech boom in the late 1990s. Below is a chart comparing the final surge in QCOM (Q4 1999) to the last three months of trading for TSLA.

In the last quarter of 1999, QCOM’s price rose by 277%. TSLA is only up 181% in the last three months and may catch up to QCOM’s meteoric rise. However, if history is any guide, QCOM likely offers what a textbook example of a blow-off top is. By 2003 QCOM lost 90% of its value and would not recapture the 1999 highs for 15 years. 

Tesla may be the next great automaker and, in doing so, own a sizeable portion of market share. However, to have estimates as high as those proposed by ARK, they must be the only automaker and assume fantastic growth in the number of cars bought worldwide. Given their technology is replicable and given the enormous incentives for competitors, we not only find ARK’s wild forecast exceedingly optimistic, but we believe it is already trading near a best-case scenario level.

One final factor that ARK Invest also seems to have neglected is the risk of an economic downturn. Although they do highlight a “Bear Case” price target of $1,500, that too seems incoherent. Given that TSLA is still losing money and is also heavily indebted, an economic slowdown would raise the risk of their demise. In such an instance, TSLA would probably become the property of one of the major car companies for less than $50 per share.

TSLA’s stock may run higher. Its price is now a function of all the key speculative ingredients – momentum, greed, FOMO, and of course, short covering. The sky always seems to be the limit in the short run, but as Icarus found out, be careful aiming for the sun.

**As we published the article Tesla was up 20% on the day. The one day jump raised their market cap by an amount greater than the respective market caps of KIA, Hyundai, Nissan, and Fiat/Chrysler!!

Looking Beyond Apple and Microsoft

As the 1970s came to a close, six of the world’s ten largest companies were in the oil exploration, drilling, and services business. Just a few years earlier, on April 1, 1976, Steven Jobs and Steven Wozniak, two college dropouts working out of a garage, formed Apple Computers, Inc. In April 1975, Bill Gates and Paul Allen formed a company called Micro-Soft.

Four decades later, these two technology startups are the world’s largest companies, far surpassing the largest oil companies of the 1970s. In fact, the combined market capitalization of Microsoft and Apple is larger than the aggregate market cap of the domestic oil industry. Even more astounding, the combined market cap of Microsoft and Apple just surpassed the total market cap of the entire German stock market.

The table below shows the rotation of the world’s largest publically traded companies over the last fifty years. Of the companies shown below only five have been in the top ten for more than one decade.

Throughout history, most of the world’s largest companies are routinely supplanted by new and different companies from decade to decade. Furthermore, different industries tend to dominate each decade and then fade into the next decade as new industries dominate. For instance, in the 1970’s big oil accounted for six of the top ten largest companies. In the 1980’s, Japanese companies held eight of the top ten spots. In the 1990s it was telecom, the 2000s were controlled by banks and commodities, and this past decade was dominated by technology and social media companies.  

Throughout history, most of the world’s largest companies are routinely supplanted by new and different companies from decade to decade. Furthermore, different industries tend to dominate each decade and then fade into the next decade as new industries dominate. For instance, in the 1970’s big oil accounted for six of the top ten largest companies. In the 1980’s, Japanese companies held eight of the top ten spots. In the 1990s it was telecom, the 2000s were controlled by banks and commodities, and this past decade was dominated by technology and social media companies.  

While table offers several insights, we believe the most important lesson is that our investment strategies must focus on the future and our dependence on past strategies must be carefully considered. Today, two college dropouts in their parent’s basement fooling around with artificial intelligence, block chain, or robotics may prove to be worth more than Apple, Microsoft, or Amazon in just a few decades. The table also emphasizes the importance of selling high and rotating to that which has “value”.

To emphasize that point, we constructed the following graph. Although simple, it effectively illustrates the theme by comparing one stock looking backward and one stock looking forward as an investment strategy. The backward-looking strategy (blue line) buys the largest company at the end of each decade and holds it through the following decade. The forward-looking strategy (orange line), with the gift of 20/20 foresight, buys the company that will be the largest company at the end of the new decade and holds it for that decade.  For example, on January 1, 2010, the forward-looking strategy bought Microsoft and held it until December 31, 2019, while the backward-looking strategy bought Exxon and held it over the same period.

Due to the split-up of AT&T and poor price data, we used GM data which had the second largest market capitalization in 1969. For similar reasons, we also replaced Nippon Telephone and Telegraph (NTT) with The Bank of Tokyo. The graph is based on share price returns and is not inclusive of dividends.

The forward strategy beat the S&P 500 by over 12% a year, while the backward-looking strategy grossly underperformed with a negative cumulative annualized price return over the last 50 years. As startling as the differences are, they fail to provide proper context for the value of 50 years of compounding at the annualized rates of return as shown. If all three portfolios started with $100,000, the backward-looking portfolio would be worth $59,000 today, the S&P 500 worth $3,500,000 today, and the forward-looking portfolio would be worth $791,000,000 today.

Summary

Although no one knows what the top ten list will look like on December 31, 2029, we do know that the next ten years will not be like the last ten. The 2000’s brought two recessions and for the first time in recorded history, the 2010s brought NO recessions. Investors need to be opportunistic, flexible, creative and forward-looking in choosing investments. Investing in today’s winners is not likely to yield us the results of yesterday. It is difficult to fathom as Apple and Microsoft drive the entire market higher, but history warns that their breath-taking returns of the last decade should not be expected in the 2020’s. In fact, history and prudence argue one should sell high.

Absurdity Spewed From Market Peaks

A recent article by James Deporre at thestreet.com asked Will Powell’s Remarks Push the Algos to Make a Move?

Deporre’s article is a recap of a day’s market events beginning with Jerome Powell’s recent testimony to Congress. He suggests that what matters are not Powell’s words, but whether computerized trading programs, known as “algos,” would buy stocks as a result of Powell’s testimony. Summarizing what ended up being an uneventful day of trading activity, Deporre made the following absurd comment which caught our attention:

“On the other hand, the mighty Apple (AAPL) is holding up and seems to function as a de facto money market account these days. It is a great place for some to park cash and that helps to keep the indices hovering near highs.” 

While we currently hold Apple stock on behalf of some of our clients, we do so with the full awareness that valuations for Apple and many other stocks are extreme. A reversion back to or below average historical valuations will result in a massive loss of wealth for many investors. As such, we maintain a careful and balanced investment posture and take nothing for granted. Most importantly, we never confuse “parking” cash with owning a stock. Like a shovel and hammer, stocks and cash are valuable tools, but neither is a perfect substitute for the other.  

What Apple Is And What It Isn’t

Apple is one of the world’s largest corporations, with innovative products and a great growth trajectory. As reported in its third-quarter 2019 earnings release, the company has a war chest of $245 billion in cash. These facts are not lost on investors. As shown below, Apple shares have risen at a remarkable pace. Since its IPO in 1984, the stock is up almost 70,000% or more than 20% annually. A $1500 investment in 1984 is now worth over a million dollars!

Data Courtesy Bloomberg

Money market mutual funds, also known as cash accounts, are vehicles that allow investors to hold cash and earn the short term rate of interest in the market. These funds invest in very short term, liquid, and highly rated securities. The investments produce little to no price volatility. Many money market mutual funds are governed by the SEC’s 2A7 rules, which greatly limit the credit and liquidity risk of these funds and attempt to ensure investors in them do not have a risk of loss of principal. Given the near riskless nature of money market mutual funds, they offer meager returns.

Buy And Hold

As the Byrds sang, “there is a season- turn – turn- turn. Similarly, there is a time to invest heavily in stocks and a time to scale back on stock holdings and take less risk. It is all too popular for market gurus, especially at market peaks when complacency is the highest, to preach about buy and hold strategies. This advice is based on a misconception that market drawdowns will be short-lived and investors will quickly recoup any losses. Therefore, it is not surprising that the popular investing view today insists that investors should check their brains at the door and remain fully invested in stocks at all times.

As shown below, such logic flies in the face of history.   

Over the long run, investors in Apple have fared better than the market. As shown, drawdowns over the last decade have been relatively short-lived. However, those setbacks have not been small. Since 2010, Apple’s stock price has dropped by 35-45% on three different occasions and by 20% on one other. So, can we treat Apple like a money market fund and hold it with the certainty of knowing that it will never lose value?

It is important to understand that, in the long run, stock prices are regulated by the cash flows of the underlying corporation. We explained this recently as follows:

“A Honus Wagner baseball card from 1909 was recently auctioned for over $3 million. While that may seem like a lot of money, it is not necessarily expensive. A baseball card is nothing more than paper and ink with no real value. Its street value, or price, is based on the whims of collectors. “Whim” is impossible to value.

Stocks are not baseball cards. Stocks represent ownership in a corporation, and therefore, their share prices are based on a series of future expected earnings and cash flows. Further, there are many other types of investments that serve not only as alternatives, but provide a means to assess relative value.

Today, investors are trading stocks on a “whim,” with scant attention to their value. Unlike a baseball card, when a stock’s market value rises much more than its real value, an inevitable correction will occur. The only question is not if, but when.”

There is an important distinction to be made here between “investing” vs. “speculating.” 

Apple’s shares are priced at a historically steep premium to its fundamentals, meaning “whim” is playing a role in recent price appreciation. Whim is speculating. Here are a few fundamental data points to consider, but as you do, keep in mind Apple has bought back a third of their shares outstanding since 2012, making per share data when adjusted for buybacks higher than that shown below.

  • Price to book value is the highest it has ever been since the IPO (12.90x)
  • Price to earnings (trailing twelve months), price to sales, and price to free cash flow are at the highest levels since 2009

Regardless of whether Apple’s valuation may appear rich, there is little doubt the valuation premium can still rise further in the future. Earnings can grow faster than expected and justify the current valuations.  However, the premium can also revert back to historical levels and earnings may disappoint in the future. Apple’s stock price dropped 61% in 2008, and that was following the release of the first iPhone. It is difficult to imagine a better time to have owned shares in the company.

Apple also appears to be over extended on a technical basis. The graph below shows the premium or discount of Apple stock price to its 50 day moving average. As circled, three of the last four times that the stock has been this far above the moving average, a drawdown of at least 20% occurred.

Data Courtesy Bloomberg

Our simple conclusion is that Apple is a speculative investment with zero guarantees and, therefore a poor substitute for a money market fund.

Sorry Mr. Deporre, but Apple is not cash. When markets drop in earnest, so will Apple, as suggested by its beta to the S&P 500 of 1.06. Holding Apple shares will not afford you the ability to take advantage of lower prices when stocks go on sale. Therein lies an important difference between the utilization of cash and stocks in a portfolio.

The graph below shows the percentage drawdowns that occurred in Apple’s stock over the last fifteen years.

Data Courtesy Bloomberg

Summary

There are two key points that Deporre’s article fails to consider. First, an equity stake in any company – whether a boring utility or hot IPO – is speculative, especially when valuations are above fair value. Value is never guaranteed, but it is far less uncertain when the price paid is below fair value. Second, cash is king when markets decline. Investors that are fully invested with little cash as an insurance policy tend to sell when markets decline rapidly. Quite often, a low is marked with a massive amount of capitulation selling.  Those who harvest gains when markets are over-valued and hold a reasonable amount of their portfolio in cash can buy stocks that trade at a discount to fair value from those who are panicking.

We leave you with an interesting graph from The Leuthold Group.

Spooked By Apple? Wait ‘Til China’s Bubble Bursts

Apple stock plunged nearly 10% on Thursday after the company cut its revenue forecast due to slowing iPhone sales in China. Apple’s woes dragged U.S. stock indices lower by more than 2% as fears of a more extensive China-driven slowdown spread.

From the New York Times:

For years, no matter what was happening elsewhere, global companies bet billions upon billions of dollars that China’s consumers would keep spending money.

Now, just when the world economy could use their financial firepower, they are no longer so quick to open their wallets.

The latest sign of a slowdown in spending in China came Wednesday, when Apple unexpectedly slashed its financial forecast, citing disappointing iPhones sales in the country. The weakness followed reams of other data — declining car sales, lagging retail spending, a slumping property market, a tougher job market — that suggest Chinese consumers may be losing their once unshakable confidence.

That could have a big impact on a world looking for engines of growth, on companies that counted on China’s continuing expansion and on global investors who have long viewed China as a steady source of profits.

Apple’s latest travails in China prompted chairman of the White House Council of Economic Advisers Kevin Hassett to warn:

“It’s not going to be just Apple,” CEA chairman Kevin Hassett said in an interview on CNN. “There are a heck of a lot of U.S. companies that have sales in China that are going to be watching their earnings being downgraded next year until we get a deal with China.”

Hassett argued that a softer economy in China is cutting into U.S. companies’ sales there and that the economic pain gives Trump leverage in ongoing trade negotiations. “That puts a lot of pressure on China to make a deal,” he said.

I agree with Kevin Hassett that many more American companies are going to take a hit from China’s slowdown and the ongoing trade war, but the risks posed by the ultimate bursting of China’s massive credit bubble are far greater, yet virtually nobody is discussing it. As the chart of China’s total debt as a percent of GDP shows, China has been gorging on debt for the past decade. This debt binge has been amplifying China’s economic growth and allowing its consumers to buy Western consumer goods like Apple iPhones.

The scary truth is that Apple and other American companies have been benefiting from China’s credit bubble, but most have no clue that this bubble is going to burst and cause a severe recession or depression in China, causing American exports to China to plunge. When is society going to learn that debt binges create temporary economic booms, but always end in terrible busts?

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