The Science of Gravity

The science of gravity.  Stocks sold off yesterday because they can’t go up every day… and maybe some profit taking. Growth stocks and tech shares were hardest hit owing to political fallout and a financial valuation equation.

 

N O T E W O R T H Y

 

High highs and low lows.  What is it about growth stocks and technology companies that everybody loves?  Well, to start, they are fun to talk about.  I remember what seems now to be like a century ago (it was really some 20-ish years ago), sitting at a big family holiday gathering.  My brother-in-law, who had a knack for picking stocks (though he was a lawyer), was talking about how much profit he made on Netscape’s stock and how every time AOL’s stock split he would simply buy the dip and hold it until the stock returned to its pre-split price.  I, being a Wall-Streeter trained in finance and economics, found myself at a loss to get involved in the conversation.  I knew all too well that a stock split did not in any way guarantee a profitable up-trade.  I also knew that Netscape, at the time had very little potential to earn money and continue to grow.  Still, talking about these stocks during that period seemed all the rage.  Both AOL and Netscape were interesting companies with new ideas and the World to conquer.  It wasn’t just those companies, there were many other interesting ones like Pets.com, Webvan, and eToys.  Who could forget the meteoric rises of Worldcom or Global Crossing?  By now, you know that many of these companies either shut down completely or were dissolved into other, larger companies.   All of those companies fell into the category of growth stocks. Though many growth companies were already well formed by the time the Dot-com bubble happened, it was really that time period which highlighted the class, or style, of stocks, which has evolved quite a bit since. Back in 2000, when the tech bubble was just bursting, the top 5 S&P500 companies were General Electric, Exxon Mobile, Pfizer, Citigroup and Cisco.  GE, the largest large cap was worth around $474 billion and Cisco was the only growth company in the top five (its market cap was around $275 billion).  These days, the top five S&P stocks are Apple, Microsoft, Amazon.com, Tesla, and Facebook.  All of them would be classified as growth companies, and all of them are clearly different.  Tesla, the new kid on the block, is expected to earn around $2 billion for 2020, while Apple is expected to earn $58 billion.  Apple’s year over year earnings growth for 2020 calendar is around +3% while Tesla is looking for a +5,752% year over year growth.  Yep, that is the actual growth number.  Now, clearly TSLA can’t continue to grow at that pace forever, but it is clear that the company has lots of great growth potential in the future.  Back in the 2000’s Apple was scoring double and triple digit earnings growths. It too showed great potential and investors who bought the stock during that period were certainly rewarded for their risk.  Back to TSLA and its supercharged earnings growth.  It is because of that growth, which many expect to continue, that so many investors are clamoring to buy the stock, and also why the stock is the 4th largest company on the S&P500.  There is some finance behind it… believe it or not. Remember that a stock price is, theoretically, the present value of all of its future cash flows.  I highlighted the equation in a geek-out-Wednesday report a while back ( https://www.siebert.com/blog/wp-content/uploads/2019/04/geek-out-topic-Stock-Valuation-1.pdf).  Forecasting those future cash flows can be difficult and a big factor in those forecasts is expected growth.  If Tesla can manage to stay on a steep growth path, its future earnings and cash flows could be tremendous. Notice how I used the word “could”, because there are still many unknowns which could challenge that thesis.  That is also precisely why the stock is so volatile.  Interest rates have been on the rise lately as a result of expectations for inflation and a healthier future economy.  Those interest rates are used to discount a company’s future cash flows and it appears in the denominator of the equation, which means that as it goes up, the theoretical valuation goes down (trust me on this, it’s just math).  A company, whose value is so dependent on future growth such as Tesla is therefore more sensitive to increased interest rates than a company which is on a slower growth trajectory.  That could explain why Tesla’s stock appeared on the top of the S&P500 losers list yesterday as 10-year yields hit 1.14%, or maybe investors decided to take some profits.  But don’t worry, there are plenty more investors who don’t necessarily know the present value equation who simply want to own the stock for its great potential.  In a similar vein, Tesla CEO Elon Musk tweeted that people should join Signal (an alternative social media platform). The tweet was misinterpreted and investors mistakenly jumped into a stock with a similar name: Signal Advance (SIGL) which has risen +6,350% since last week’s tweet. The small thinly-traded medical device company, I am sure, has some great potential.  I am not so sure that my brother-in-law bought it in time though.

 

 

THE MARKETS

 

Stocks sold off yesterday as investors took profits, and a well-needed day of rest from the recent rally.  The S&P500 fell by -0.66, the Dow Jones Industrial Average slipped by -0.29%, the Russell 2000 Index gave up -0.03%, and the Nasdaq Composite Index dropped by -1.25%.  Bonds fell and 10-year treasury yields added +3 basis points to 1.14%.

 

NXT UP

 

– This morning NFIB Small Business Optimism (Dec) missed expectations coming in at 95.9, down from the prior month’s 101.4 level.

– JOLTS Job Openings (Nov) may have fallen to 6.450 million from 6.652 million.

– Fed speakers include Brainard, George, Rosengren, Kaplan, and Kashkari.

 

 

 

daily chartbook 2021-01-12