Tech Continues To Ramp
Friday was an amazing day for tech stocks as the Nasdaq increased 2.20%. The Dow rallied a few days ago because big companies within it reported great results. Today was the Nasdaq’s turn as MSFT, GOOGL, and AMZN all reported great results. Even companies which didn’t report were in on the action as Apple - AAPL was up 3.58% possibly on optimism about the iPhone X and Facebook - FB was up 4.25%. One company I didn’t discuss in the previous article was Intel which also had a great report. Adjusted earnings were $1.01 which beat estimates for $0.80. The company also raised full year guidance from $3.00 in EPS and $61.3 billion in revenues to $3.25 in EPS and $62 billion in revenues. This led Intel - INTC stock to increase 7.38% to an all-time high.
The optimism in equities is absurd as Q3 earnings reports look good so far in what was supposed to be a weak quarter because of the hurricanes. The only other time since 1990 that the S&P 500 was up over 0.75% to a new all-time high with this amount of advancing versus declining stocks was November 18th, 1999. We’re in an unusual time where earnings are justifying stock price increases which have previously been unthinkable. The chart below shows the changes in the market caps of the top 4 tech stocks. As you can see, AMZN added almost $62 billion in market cap in one day. The scary part about that for the bulls is the earnings estimates for Amazon were lowered to make the beat easy. In June 2017, the estimates for Q3 were slightly over $1. The report came in at $0.50. It beat estimates for $0.03, but it didn’t beat enough to match the estimates from 4 months ago. The other tech firms didn’t have their estimates lowered in that fashion. If you’re a bear, you’ll focus on Amazon’s low profit margins and NFLX’s negative free cash flow. If you’re a bull, you will focus on the profit growth of Microsoft, Alphabet, Apple, and Facebook. Apple reports earnings November 2nd and Facebook reports November 1st.
Great GDP Headline
The GDP report came in at 2.95% which beat expectations for 2.6%. Those are the fastest back to back growth quarters since Q2 2014 which had 4.6% growth and Q3 2014 which had 5.2% growth. That was the peak of S&P 500 earnings which has been broken this year. Some investors are shifting their attention to inflation with these solid growth reports. Core inflation actually wasn’t that high in 2014. It was in between 1.5% and 2.0% in 2014. It peaked at 2.33% in February 2016. Clearly, we can have real GDP growth without inflation. However, the thought process is if GDP growth stays high for another few quarters, unlike the previous bursts in growth which have been short, then inflation will be spurred.
Stocks might have sold off on the news of the great GDP report because of inflation fears, but it’s tough to tell because great earnings reports lifted the indexes. Now let’s get into the details of the report. As you can see from the break down below, the growth mostly came from personal consumption which was up 2.4% and contributed 1.62% to total growth. A big portion of this improvement came from motor vehicles. As you remember, car sales accelerated in September because of the hurricanes. There was also a big jump in private inventories. We’ve seen inventories increasing in some of the Fed reports as the supply chain is out of whack. The increase in wholesale and manufacturing inventories drove most of this jump. As I mentioned, the inflation numbers are getting more important as they increase.
The core PCE increased 1.3% quarter over quarter which was an acceleration from the 0.9% growth last quarter. Overall PCE increased 1.5% which beat expectations for a 1.2% increase. The BEA stated that it can’t separate the effects from the storms from the report. I think that the weakness in late August and early September was cancelled out by growth from rebuilding in the middle to end of September.
Besides the bears harping on the inflation stats, the other criticism is this report had a good headline, but not good underlying numbers. As you can see from the chart below, the final domestic demand growth was below the 40th percentile making it one of the weakest quarters of this expansion. Quarter over quarter annualized demand growth was below 2%. Because of the hurricane related effects, I think this quarter is more likely than average to see big revisions in the coming months. It’s worth taking a look at the underlying numbers instead of just the headline number because the you can look at the underlying numbers to see which parts don’t make sense. It’s entirely possible the estimates for inventories are wrong meaning the GDP headline could be revised lower.
Let’s quickly review the various estimates for GDP to understand the track record of these forecasts. The GDP Now report was fairly close as it came in at 2.5%. The NY Fed forecast was completely wrong as it expected growth to be 1.6%. Interestingly, the Q4 GDP estimate increased from 2.61% to 3.05%. In Q2 the NY Fed was optimistic, in Q3 it was pessimistic, and now it looks optimistic again in Q4. Back when it was below 2%, I said it would move higher because of rebuilding. The new single family homes sold report added 0.19% to the estimate. If Q4 GDP is above 3%, it would be one of the best streaks of this expansion. Finally, the St. Louis Fed estimated growth would be 2.92%. That’s almost a perfect estimate.
Conclusion
This week was almost as good as it gets. Most of the major tech companies beat estimates and GDP had a great headline beat. The ECB cut QE just as expected. The only thing we didn’t get was Trump’s Fed chair pick. It should come early next week.
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