Apple Drives Frothy Market Lower

Apple Drives Market Lower On Monday

Apple Drives the Dow, the Nasdaq, and the S&P 500 lower. But the Russell 2000 also fell, so that’s not the whole story. First let’s look at Apple.

Apple stock fell 2.06% on Monday after an analyst from Rosenblatt stated the iPhone XS may end up being "one of the worst selling iPhone models in the history of Apple." He also thinks growth in services sales will slow.

Apple has tried to make its services division look more important than iPhone sales through its reporting tactics. If services slow, Apple’s plan will have backfired. The stock is still very elevated. Ao if there is weakness, it has plenty of room to fall.

As you can see from the chart below, the EV/EBIT multiple has never been this stretched versus the FCF yield since the iPhone was introduced.  

Specifics Of the Action In Stocks

Apple Drives - S&P 500 fell 0.48%, Nasdaq fell 0.78%, and Russell 2000 fell 0.9%.

Apple was a factor in the decline in the first 2 indexes. But I also think stocks fell because they got overbought last week. And also because the Fed probably won’t cut rates 50 basis points on July 31st.

It’s better to see economic growth improve than the Fed cut rates. But the market wanted a perfect scenario. One where the economy started to rebound, Fed cut rates, and Trump made a trade deal.

Maybe investors think this is the end of the cycle. Meaning a 50 basis point cut is needed. Many investors who thought the cycle was near its end prior to the jobs report probably still think so. One jobs report shouldn’t change your outlook.

There was investor greed last week for the first time in a couple months.

Apple Drives - It’s surprising it took so long for greed to accumulate given how much stocks rallied prior to last week. CNN fear and greed index fell 2 points on Monday to 59 which kept it in the greed category.

As you can see from the bottom chart, 59.6% of S&P 500 firms are above their 50 day moving average. Only 3.6% of stocks are below their 50 day moving average. This spread puts the market in overbought territory.

Once it gets to 2 standard deviations above normal, it will be extremely overbought. It’s in a similar territory to where it was in April before the correction this spring. S&P 500 is ripe for another 5% decline in July.

Apple Drives - It’s no surprise that the tech sector was down 0.73% as it was hurt by Apple.

However, it wasn’t one of the worst performers. Worst 2 sectors were the materials and communication services which fell 1.06% and 0.9%. Best sectors were real estate and consumer discretionary which were up 0.37% and 0.19%.

Amazon stock was up 0.48% which helped the consumer discretionary sector. It is about $10 off its 2019 closing high of $1,962. Its record high was $2,040 in September 2018.

Lately, the market hasn’t been driven by the famous FANG names. They will still be important come earnings season later this month and in early August. Amazon reports on July 25th and Apple reports on July 30th.

Earnings Update

Apple Drives - Earnings season will get into gear next week with the big banks reporting results. Main question many have is if earnings growth will rebound sharply in Q4 like the estimates in the chart below show.

As you can see, estimates for Q2 earnings are slightly negative. However, since estimates are almost always beaten, we expect low to mid single digit earnings growth.

Personally, I think it will be somewhere from 3.5% to 5.5%. Estimates usually start in the high single digit to low double digit growth range. That’s autopilot for analysts.

Once economic data comes out and guidance is released, the estimates reflect reality. At one point estimates for Q2 2019 earnings were much higher, for example.

Therefore, question is if 2020 EPS growth will be somewhere between 8% and 12%. That question won’t be fully answered after this quarter though. I ask it because some are calling for a recession while the market is near its record high.

Apple Drives - Contrary to popular belief, earnings estimates don’t need to be steady or rise for stocks to rally.

If growth come in near that level, the S&P 500 will make a new high that’s much higher than this recent range of new highs were there hasn’t been a true breakout.

71% of the first 21 S&P 500 firms to report earnings have seen their Q3 EPS estimates lowered. Even though Micron beat estimates, it had its Q3 estimates lowered 22.03% which is the worst decline out of the firms that have reported so far.

One of the most notable firms is General Mills because it is up 39.14% year to date while its Q3 estimates fell 3.8%. It’s a bad combination for earnings estimates to fall sharply and the stock to rise sharply. It’s up so much because of its terrible 2018. That’s something it has in common with the S&P 500.

As you can see from the chart below, the S&P 500’s earnings were up substantially in 2018 and its multiple contracted because stocks fell.

Now in 2019, earnings growth is low, but the returns are high. It’s notable that earnings comps are tough this year, so expecting high earnings growth was always unrealistic. Global economic slowdown doesn’t help either.

Stocks won’t be able to ride multiple expansion again in 2020. Which is why its earnings growth is so important.  

Apple Drives - Conclusion

Stocks fell because they were frothy, Powell won’t be cutting rates twice in July, and Apple’s stock fell. The market’s reliance on Apple probably isn’t a good thing because of how expensive it is.

It’s highly unlikely that 2020 will see anywhere near the gains seen in 2019. If the S&P 500 is to make gains of even 5% to 10%, it will need to see significant earnings growth similar to what expectations are now.

Most people underestimated stocks this year because they feared a recession. I’m not cautious on stocks for next year because of a recession. I just think stocks are fully valued. If there is a recession, that obviously makes matters much worse.  

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