International Markets Drive Revenue Growth
It’s not a surprise the small caps, which are mostly domestically focused, have lagged the S&P 500 in terms of margin expansion and revenue growth because the domestically focused firms in the S&P 500 have had slower growth than international firms for the past few quarters of this expansion. This is partially because American growth is lower than global growth and partially because most tech companies have a high international focus and that sector is a growth engine. Low growth sectors like telecom, utilities, and real estate have a high domestic focus.
The chart below shows the Q1 estimates for earnings and revenue growth for domestically focused and internationally focused firms. As you can see, the difference between international earnings growth and domestic earnings growth is 3.2%. Clearly, the difference has tightened because the principal catalyst for earnings growth in both groups is the tax cut. The revenue growth difference is 5.6% showing that the domestically focused firms are seeing more margin expansion than international firms and that the growth outperformance for international markets will continue.
The earnings expectations for Q1, 2018, and 2019 were all stagnant in the past week. They are about to start falling in the next few weeks. On the one hand, stocks have rallied in previous years when earnings expectations have fallen. On the other hand, stocks seem to be affected by the negative headlines more this year which means the positive catalyst of increasing earnings estimates not being there to boost stocks is particularly damming. Personally, I’m fine with buying stocks if earnings growth 10%-15% rather than the expected 18% growth. That being said, I expect the market to be range bound since the economic data has been weak in February.
One misleading point the financial media is making is that the tariffs and volatility in the White House are the only reason stocks have been weak in the past 6 weeks. The reality is the economic data is playing an important part in this range bound market. If my assertion is correct, the market might be range bound for the next few months because that’s when I think the economic data will improve. Earnings growth expectations will slow their decent in the 2nd half of the year because the economy will be stronger than the first half.
Facebook Stock Falls On Bad Headlines
On Monday afternoon, Facebook stock was down 7% because of the weekend story which stated Cambridge Analytica used Facebook’s platform to create its app “thisisyourdigitallife” which asked users psychological questions to gain information which helped it model elections. The key point in the story is this wasn’t a data breach. It was Cambridge Analytica using Facebook by lying about the use of the data, saying it was for academic purposes and the users who filled out the survey would be anonymized. Facebook suspended Cambridge Analytica 2 years ago. This story shows how powerful Facebook’s tools are. That’s great for advertisers, but it could prompt more regulation of the social network by the government.
I don’t think this one incident is the reason Facebook’s stock got hit. It’s the straw that broke the camel’s back because Facebook has been facing scrutiny about privacy issues and how its tools could be used to manipulate elections for months. It’s great for the stock that its products are used by so many people and that its ad targeting is amazing. Unfortunately, this opens it up to more regulations because it gets the brunt of the scrutiny when web privacy concerns flare up and when news about election tampering is reported.
Facebook is able to monetize users better than Twitter because it knows more personal information. Up until recently, that has been an unmitigated positive since the profits have flowed through. Now Facebook could be paying the price for knowing so much about its users. To be clear, the government issuing fines and regulations would be better than its users fleeing the social network for other products like Snapchat and Twitter. With regards to the election, Facebook is trying to be a neutral place for everyone to discuss their opinions, while taking money from campaigns for advertisement. That’s a tough balance to maintain because Facebook has been pressured to crack down on extreme posts and “fake news.” I’m not saying it’s wrong or right for Facebook to do this; I’m saying it’s a difficult task because every side of the political spectrum will claim it is getting unfairly targeted by the firm.
Facebook stock will fall way more than 7% if users flee the product. The worst case scenario is Instagram users realize it is owned by Facebook and boycott the service as well. I think the stock’s correction only reflects the potential fines and potential for political campaigns to be limited in how they advertise on Facebook.
I know this is anecdotal evidence, but I think it’s worthwhile to consider. Facebook became a serious platform when older people began to use it. When your family and employer see your posts, you limit what you say. It’s not a good idea to offend a family member or co-worker. Therefore, people are sharing less on the network. That’s a long term social change that the network probably won’t be able to solve. You can limit who you can see your posts, but that’s a hassle for people. They’d rather just limit sharing. The ability to have an anonymous account on Twitter could end up being an advantage in the coming years as people worry about getting fired over a post on Facebook.
Conclusion
International revenue growth continued to boost the S&P 500. Tech is the most important sector because it has multinational firms which are growing quickly. The controversy Facebook is facing is an example of the risk all major tech companies face. Regulations on Google, Facebook, and Amazon could be coming to limit their power. Europe is the place where regulations and fines are most likely to be issued because we’ve already seen some. The fact that these are American firms also contributes to the fines as it can be considered a form of protectionism.
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