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technology shares

Oh Mr Zuckerberg

You've probably seen the news at Facebook. The stock is down 20% in after hours trading (after hours volume is notoriously thin so we’ll see better indications tomorrow). Why?

  • User growth was less than expected
  • Revenue growth revised down in 2H 2018
  • Expenses up
  • Missed (only slightly but there’s little margin for error with a stock like FB) advertising revenue target
  • Headcount up 47% YOY

•  Some negative comment about the EU privacy regs General Data Protection Regulation (GDPR…expect to hear more of this) where they lost 1m subscribers due to the new rules.

•  Quotes from the transcript (here) that probably didn't help:

  “…deceleration in ad revenue growth, kind of consistent with the trends we've seen” CFO

  “…because the effective levels of monetization in Stories [videos and photos with a story; disappears in 24 hours] are lower.” CFO

  “We're being very slow and deliberate with monetization [with Messenger]” COO

  “But we won't know for a while if it's going to monetize at the same rate [when FB places stories across Messenger, Facebook and Instagram]”. COO

  “[Europe monthly average usage (MAU) was down] On Europe, yeah, we don't have any update on trends. We had indicated in the first quarter that we would expect to see a decline. We're not providing any guidance on MAU and DAU in Europe on this call.” CFO

Short term:

Some of the +30% growth days must be numbered. This is a stock that's under regulatory scrutiny but, unlike Google, the facts aren't known yet. There wasn't one reason for the miss…just lots of small ones such as privacy, currency, new ad formats etc. Since 2013, revenue and expenses have “beat” (i.e. been better than forecasts) by 5% to 7%. This time they missed by 1% and 2%. So, that's new for them.

Cash Fortress

FB has a very strong balance sheet. More than $50bn in cash which is half the balance sheet. Operating margins dipped but are at still at 44%.

Bull case:

  • new products
  • management tends to guide low
  • mobile ad volume
  • ad pricing
  • not overly expensive

Bear case:

  • regulatory problems will grow
  • slower growth
  • expenses higher
  • opting out/privacy issues

Bigger picture:

We’ve written about the FAANGs a fair amount in recent blogs. They’re big, profitable and growing. But there are high expectations around the stock and it sells at 75% more than the market and 85% more than Apple.

It’s one reason why we like small cap and the dividend Aristocrats. They lag when Big Tech is on a run but they're less likely to have a big sell off.

Action: Many clients have low cost positions in FB, so selling is not always an option. The stock is not going to crash. It’s a 20% correction so needs a 25% increase to break even. We'd certainly trim where possible if only for diversification reasons and we can help on that. Also, if you have tax gains elsewhere, or want to create a loss to offset some current income, we can help on that too. But otherwise it’s a HOLD.

If there’s more, we’ll include it in the blog. If you need more, please let us know.

Chart:

High ROE, EPS growth of 40% and large cash position

 --Christian Thwaites, Brouwer & Janachowski, LLC

 Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

 

Always something happening and nothing going on

The Days Ahead: The European long holiday keep things quiet. Jobs number on Friday.

One Minute Summary: We had three out of four trading days where the market moved by more than 1.3%. But there was no change over the week. Bonds had a good week. European markets were up but Asian stocks are still trying to figure out what the trade talks do for them. Companies like Toshiba, Sharpe and Nintendo were down 6% to 8%. The Euro and the Yen took a break from their steady rise this year but that was probably due to some cross-currency funding needs of major banks (the rule on overnight funding changed with tax reform).

Stock volatility feels high. But it's no different from its long-term average. Stocks have gradually got cheaper these last few weeks. We've seen no downward revision of earnings. While the economy is not quite the tear the tax cut crowd thinks, we’re a long way from recessions and economic downturns. Sentiment is shaken but if that flushes out some of the fast money especially at a quarter end, then… good.

1.     Tech Wash Out. When companies grow big and dominant they attract attention. In Europe, it tends to come with taxation. In the U.S., it's regulation. The driving themes of tech in the last few years were a mix of i) almost measureless scalability ii) the network effect (i.e. the more people use something, the more valuable it becomes to the community) iii) growth and iv) real oligopoly. These are exactly the same arguments in the last tech boom, the IBM and BUNCH stocks in the 1970s and all the way back to the Bell System in the 1900s.

It was perhaps inevitable that one or more of the current tech leaders would trip. It happened to be Facebook. It wasn't the first to break the rule of corporate communication (don't let the lawyers run your PR) but it did an outstanding job of going to ground and coming up with a sort-of-sorry mistakes-were-made-apology. But when investors are looking to sell stocks that had massively outperformed the market over the last three years, then any news becomes a reason to sell. Europe thinking about imposing a sales tax on tech companies. Sell. Tesla’s debt downgraded. Sell. Nvidia, a stock that has risen 700% in two years, said it won't be testing autonomous vehicles for a while. Sell. Twitter and privacy. Sell.

Tech has had phenomenal run. And it’s not nearly as overbought as in the 1990s. Here’s a chart showing the performance of tech against utilities, the ultimate defensive sector, in the 1990s and in the last 10 years.

It certainly looks like a bubble but on a much smaller scale. What concerns us is that many investors have left conservative investments and put an awful lot of faith in a few growth stories. For the last five years, tech has beaten utilities hands down, up 150% against utilities up 54%. But since the 2000 tech peak, it’s a very different story. Tech has risen 78% and utilities by 224%. It took 14 years to get back to break-even if you’d bought tech in 2000. For utilities it was just over four years.

So? Well we’d just reiterate the theme that diversification is very important. And we’d expect this period of volatility to continue.

And from the history rhymes library, here’s a pretty fierce response from the head of AT&T when the government started the breakup of the Bell companies in 1981.

2.     What’s the bond market saying? That growth isn’t going to last. And that inflation won't be a problem. We feel pretty confident about the second. Primarily because we think there’s more slack in the labor market than many realize. We wrote about it here. On the first, though, you've probably heard about the yield curve flattening. This is when short-term rates increase but long term rates stay sticky. There are lots of ways to measure it but here's the spread between 3-month Treasury bills and 10-Year Treasury notes.

Even at the height of QE when the Fed bought every Treasury and MBS in sight and so pushed yields down, the spread was 2.25%. After the election, in the heady days of growth, deregulation and tax cuts, it steepened sharply. But it's been falling ever since and especially so this year. It's now down to 1.02%.

To us, the market is saying that i) tough trade talk may sound good but there is probably nothing economically constructive that can come out of them ii) the twin deficits are going to need financing and the financing is going to come at the short end of the market and iii) the markets are nervous about growth. So, why not hold longer term Treasuries because they're not going to change…only the short end will.

That's our view certainly. We really don't believe in the “bear market for bonds” hype. We think rates are pretty well underpinned at the 2.7% to 3.0% range and will stay there for much of the year.

Bottom Line: Another short week. Asian markets grappling with the trade tariffs. As clients know, we’ve placed some protection on U.S. stocks. Expect volatility to remain high.

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Other:

Berkshire Hathaway is now the country’s second largest realtor

--Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.
All charts from Factset unless otherwise noted.