- Martin Sosnoff
Black Monday For Prime Growthies?
They didn’t drag out Microsoft to be shot last week, but it did shade its recently posted high mark.
Microsoft shines as the poster child for the bull market. It has risen steadily over 5 years from $60 to $323, over 500%. I find myself in a Warren Buffett kind of quandary. Why sell and make Uncle Sam richer? Yes, Microsoft sits at nearly 2 times valuation of the S&P 500 Index, a heady premium. But, it sports a clean income statement with a major position in cloud computing.
Microsoft stands as one of the few growthies I can model for next couple of years. Any analyst who thinks he can build a credible income statement for Amazon, Meta Platforms and Tesla surely is whistling into the wind. Quarter-after-quarter, year-by-year, these statisticians widely miss their numbers.
Past week’s downward flurry you can lay at the feet of Federal Reserve Board pronouncements. How they intend to deal with persistently troublesome inflation readings, particularly in energy and wages. Remember, Paul Volcker took interest rates up to 15% to rid the country of its inflationary expectations back in 1982 – ’83. Jimmy Hoffa kept squeezing auto makers for 7% wage increases. Detroit caved in and raised car prices.
Such a gambit made General Motors and Ford uncompetitive with Toyota, Honda and Volkswagen. They ate our lunch, and later years, General Motors needed to be bailed out by the U.S. Treasury.
Our FRB is a little late in tapering off purchases of Treasuries which created excessive bank reserves, a potent monetary stimulus gambit. The FRB carries over a trillion in government bonds and needs to lighten up next 12 months.
So investors must deal with the equation of what rising interest rates can do to the valuation structure of the stock market. Yields on Treasuries are incredibly low both absolutely and by historical comparisons. Anyone sitting with 1-year, 5-year, 10-year and 30-year Treasuries certainly holds a losing hand.
Ten-year Treasuries now yielding 1.4% historically range into much higher ground when money gets tight. Conversely, price-earnings ratios normally then contract. When long-term Treasuries sell to yield 4%, the market can trade at a mid-teens price-earnings ratio. Currently, we’re over a 20 multiplier on next year’s earnings expectations which are blandly bullish, up 10%.
When the Fed is tightening interest rates the market rarely runs contrapuntally higher. I’d draw a trendline through 4% for Federal Funds. Currently, I’m arbitraging the high-yield bond market yielding 4.5% with Fed Funds under 1%. This spread could change markedly, even next 90 days.
In December of 2000, Microsoft touched down at $40, one-third of its 1999 peak. The market was saying Microsoft had lost it, just another IBM. A month later, Microsoft sold at $61. They had flattened out discretionary spending for R&D and marketing, thereby maintaining gross margins at 85%, thereby meeting earnings forecasts.
Over the years, gross margins trended down to 65%. The igniting factor for the stock was the healthy revenue line for server software. Later, cloud computer software took over. Gross margin still hold in the 70% range today. Unless I see contraction in Microsoft’s gross margins, I’m willing to absorb market risk in the stock.
Because the economic setting is more conjectural than ever, I’ve rotated sizable capital into healthcare properties which historically can be contrapuntal movers. Revenues and operating profit margins normally hold up. But, who is to say what the growth rate will be for Pfizer, which presently carries enormous revenue enhancement from its drugs working against COVID-19 and its mutations?
I’m impressed with the strong healthcare franchise of UnitedHealth Group and Zoetis where I am not sure of its correct pronunciation. If they named themselves “International Animal Healthcare,” it would broaden meaningfully its shareholder list.
And, then, I still hold stocks that saw the wolf at their door 18 months ago. I’m talking about my beloved ragamuffins: Macy’s, American Airlines, Alcoa, United States Steel, even Citigroup and Ford. They’ve corrected some, but if the Fed flexes its muscles, it’s a long way down. I’ve lightened up.
Etched into my memory bank is the 1983 market which touched down at book value, yielded 5% and sold it 10 times earnings. You’d need to cut our current market in half to reproduce such fundamental metrics. The financial meltdown of 2008 – ‘09 did plumb such a bottom when the U.S. Treasury intervened with massive funding for our banks and brokers.
My 50-year-old vision for a great market is Secretariat galloping down the middle of the track, alone, 31 lengths to the good. This was some 50 years ago. Seabiscuit, who raced during the Great Depression, was the $2 bettors’ favorite, a come-from-behind horse who’d cast a wicked eye at his competitors as he drew aside them.
Still waiting for Microsoft’s headman to explain why he sold half his stock holdings, serious money. But, I’m not holding my breath. I’ll never forget I’m just a number on my broker’s ledger.