Quotidian Investments Monthly Commentary – April 2018
Following the fluctuations of March, equity markets were smoother in the early weeks of April but that calmness soon turned out to be a false dawn as volatility returned with a vengeance in the last ten days of the month when intra-day price swings of 5 to 6% were commonplace.
For many years past we have observed with a mixture of amusement and amazement the institutional myopia (or blinkered idiocy) of market analysts and, by extention, their influence on market makers and equity pricing. If we were to compile a list of all the predictions (both by number and in percentage terms) that analysts got wrong and still consistently continue to get wrong it would challenge War and Peace for its lack of brevity.
It never ceases to surprise us that these organisations (which largely comprise the major investment banks) scour the best universities for the best brains but when these very talented people are inducted they are then discouraged from independent thought (or, indeed, any thinking at all) in favour of accepting without question a bland, prosaic, superficially risk-averse house style. In many cases, however, they often fail to grasp more profound and meaningful concepts of risk at all. Strangely though, they tend to be highly attuned to the concepts of corporate profit and self-enrichment.
These highly trained analysts are employed to make assumptions and prognoses on economic and geo-political issues; their assumptions very quickly mutate into ‘fact’ and, because very few dare to be out of step with the mainstream, then group-think is allowed to prosper. Whilst arrogance, compalcency and the certainty of their own infallibility causes relatively short term negative effects on equity valuations, it also has the benefit of providing investment opportunities and good value for those with an alternative (perhaps more considered and less self-interested) viewpoint.
Under specialist utilitarian training the intelligence, open-mindedness and natural optimism of youth is quickly transformed into an army of Jeremiah’s*; Jerry can swiftly becomes Jerry can’t. Perhaps if this army could be matched with a similar number of Cassandra’s** then between them they could continue to produce tediously depressing off-beam and negative analysis but nobody would actually believe it. That fanciful piece of wishful thinking will, of course, never become reality but it might at least give us some relief from these regular periods of pointless and synthetic market turbulence.
On 30th April 2018 the FTSE100 closed the month at 7509.30, a rise of +6.42% for April and it now stands at -2.32% for the 2018 calendar year to date.By comparison the Quotidian Fund’s valuation at the same date shows a profit of +1.38% for the month and the Fund is now standing at down –0.02% for the 2018 year to date.
Some analysts are more read (or should that be more red) than others but one example will suffice to illustrate the point I am trying to make about the poverty of mainstream analysis in general:
The share price of Facebook at close of business on 16thMarch was $185. The following day the ‘privacy scandal’ involving Cambridge Analytica’s apparent misuse of the personal data they had obtained from Facebook became public and this army of insightful analysts sprang into action. En masse, they made the assumption that this manufactured ‘scandal’ would cause catastrophic falls in customer numbers which, in turn, would lead to a huge drop in advertising revenue and profitability. In effect they were predicting that this could signal the demise of Facebook and by 27thMarch its share price had been marked down to $152. By association, the tech sector generally was also priced downwards across the board by circa 4%.
As we had signalled in our March report, the 2018 first quarter reporting season was just beginning and, with their share price having been under the cosh since 27thMarch, Facebook issued their latest results after market on 25thApril. Far from being in accord with analyst’s gloomy predictions, earnings per share were $1.69 (24.8% higher than analyst’s estimates of $1.354), and the number of monthly active users had increased to a not insignificant 2.2 billion (in the previous earnings report for 4thquarter 2017 it was 2.13 billion). Naturally, this will have a positive effect on future revenue and earnings per share.
In the blink of an eye, Facebook’s share price was revised substantially upwards again and is currently trading at $175 and it will go higher again. It is worth noting that in 2008 Facebook’s revenue was $272 million for that entire year; in 2018, its revenue is now $272 million every 2 days!
A similar story applies to the tech sector in general and the likes of Amazon, Apple, Google and Netflix in particular. Amazon’s share price was marked down, for entirely artificial reasons based on poor analytical judgement, from $1605 on 12th March to $1371 by 2ndApril.
Amazon’s results (released after market on 26thApril) were also exceptional (in complete contradiction to so-called ‘serious analysis’) and its share price immediately after the results were released soared up to $1625. We now expect to see the dark cloud that has been (deliberately) held over this sector for much of the past few months to be progressively lifted.
In view of the persistently negative reports and analyst’s warnings in relation to the tech sector it is worth emphasising that this sector includes the five largest companies in the world in terms of their market value. Quotidian has an equity holding in each of them. These five companies rarely sem to find favour in analyst’s reports but collectively they are worth more than the entire economy of the United Kingdom. Together they are currently valued at $3.5 trillion; the gross domestic product of the U.K. was just $2.6 trillion in 2017. In fact, only four national economies are larger than these tech giants combined: those of the USA, China, Japan and Germany. Despite their current size, they are still growing and making extraordinary profits.
Facebook, Microsoft, Amazon and Google (aka Alphabet) reported exceptionally large profits last week.
Facebook’s profits were almost $5 billion in the first quarter of 2018. That is equivalent to $56 million a day, $2.3 million an hour, $39,000 a minute. Amazon’s profits more than doubled and the fifth(Apple) releases its latest set of earnings on May 1st.
Apple makes roughly $151 million every day (a figure calculated from the company’s expected profit in the January/March quarter and which will be released after market on May 1st).
Google and Facebook can afford to offer free services thanks to their hammerlock on digital advertising. These two companies will sell an estimated $61 billion in US online advertisements this year according to reliable research from eMarketer. That is roughly a quarter of the expected total spending in the USA on all forms of advertising and yet it is all in the hands of just these two companies.
Amazon has just announced that it is raising the annual price of its Prime membership program for customers in the USA from $99 to $119, This simple change will generate an extra $2 billion for the company. Incredible.
The current US earnings season is shaping up to be one of the best in the last 20 years (based on the percentage of companies that are beating estimates). To return to my main theme, by the end ofApril those companies that have already reported their results have mainly posted phenomenal earnings and profit figures. Indeed, nearly three-quarters of those companies that have thus far reported have beaten analyst’s expectations.
These companies are not currently being rewarded with higher stock valuations. Instead, prices are basically flat despite these strong earnings reports but when the prevailing period of negativity passes then the financial reality of these achievements cannot simply be ignored; eventually they will have to be factored in to equity values.
The other item of April’s economic news that needs to be mentioned here is that on 24thApril the yield on US Treasury Bonds briefly hit 3%. You may recall the relevance and importance of that figure from our various briefing reports over the past year. If one can achieve a 3% yield with no risk to one’s nominal capital (other, of course, than the effect of inflation) then some investors will be tempted to move from equities into Treasury Bonds.
However, the 1o year yield has already slipped back again; if and only when it establishes itself above a 3% yield would we expect a relatively small amount of slippage from the equity markets into government debt.
The real importance of this issue it to stress again how vital stock selection, insight and patience are in order to firstly create and then maintain an equity portfolio which can provide attractive, above average investment returns combined with a reasonable level of security. This is Quotidian’s raison d’etre.
* Jeremiah – the weeping prophet, relentlessly negative
**Cassandra – whose prophesies were sometimes right but nobody believed her anyway