by Adam Hamilton of Zeal LLC
The fundamentals of the gigantic American companies dominating the major indices are more important than ever. The US stock markets plunged into a bear market last quarter, hammered lower by the Fed’s extreme tightening. That along with raging inflation also slammed the US economy into a recession. So how big US stocks are faring as revealed in their just-finished Q2’22 earnings season is crucial for their outlook.
The mighty S&P 500 (SPX) is the flagship benchmark US stock index. Not only is it closely watched by nearly all traders, its largest component stocks are heavily-owned by the vast majority of investors. The huge SPY SPDR S&P 500, IVV iShares Core S&P 500, and VOO Vanguard S&P 500 exchange-traded funds are the biggest in the world by far, with colossal assets this week of $382.1b, $313.6b, and $273.8b!
Q2’22-proper proved miserable for the SPX, which suffered a serious 16.4% loss. At worst by mid-June, the biggest US companies’ stocks dominating this broad-market index had plunged 19.1% quarter-to-date! That extended their collective losses since early January to 23.6%, crossing the bear-market threshold down 20%+. Despite a bear-market rally into quarter-end, the SPX was still down 11.9% year-over-year.
Along with a confirmed bear market underway, Q2 also saw the Federal Open Market Committee hike its federal-funds rate by 50 basis points in early May then another 75bp in mid-June! This uber-hawkish Fed also launched its unprecedentedly-huge second quantitative-tightening bond-selling campaign in June. It is scheduled to ramp to $95b monthly in September! These are fierce bearish headwinds for big US stocks.
Easily the Fed’s most-extreme hawkish pivot ever, it also bludgeoned the US economy into a technical recession. Last quarter’s initial US gross-domestic-product read retreated at a 0.9% annualized pace, following the preceding quarter’s -1.6%. Two or more sequential quarters of GDP shrinkage is the classic recession definition. The Fed’s driving aggressive rate-hike cycle and QT2 are reactions to raging inflation.
During Q2, the monthly headline US Consumer-Price-Index inflation reads averaged red-hot 8.6%-YoY surges! Of course the Fed’s epic money printing is the primary reason inflation is out-of-control. In just 25.5 months into mid-April, the Fed’s balance sheet mushroomed an epic 115.6% or $4,806.9b! After recklessly more than doubling the US monetary base in a couple years, the aftermath is panicking the Fed.
All this makes for an exceedingly-challenging environment for the largest US companies. This biggest inflation super-spike since the 1970s is eroding their earnings, they can’t pass along all their higher input costs. Heavily-indebted after years of zero-interest-rate policies, higher rates are catapulting debt-service costs higher. They’re also making borrowing more money for financing stock buybacks prohibitively-expensive.
How the big US stocks actually fared operationally last quarter offers crucial insights into whether their young bear market will likely deepen. For 20 quarters in a row now, I’ve analyzed how the 25-largest US companies dominating the SPX did in their latest earnings season. As Q2 ended, these behemoths alone accounted for a heavily-concentrated 42.2% of the entire S&P 500’s weighting! They are detailed in this table.
Each big US company’s stock symbol is preceded by its ranking change within the S&P 500 over the past year since the end of Q2’21. These symbols are followed by their stocks’ Q2’22 quarter-end weightings in the SPX, along with their enormous market capitalizations then. Market caps’ year-over-year changes are shown, revealing how those stocks performed for investors independent of manipulative stock buybacks.
Those have been off-the-charts in recent years, fueled by the Fed’s zero-interest-rate policy and trillions of dollars of bond monetizations. Stock buybacks are deceptive financial engineering undertaken to artificially boost stock prices and earnings per share, which maximizes executives’ huge compensation. Looking at market-cap changes rather than stock-price ones neutralizes some of stock buybacks’ distorting effects.
Next comes each of these big US stocks’ quarterly revenues, hard earnings under Generally Accepted Accounting Principles, stock buybacks, trailing-twelve-month price-to-earnings ratios, dividends paid, and operating cash flows generated in Q2’22 followed by their year-over-year changes. Fields are left blank if companies hadn’t reported that particular data as of mid-week, or if it doesn’t exist like negative P/E ratios.
Percentage changes are excluded if they aren’t meaningful, primarily when data shifted from positive to negative or vice-versa. These latest quarterly results are very important for American stock investors, including anyone with retirement accounts, to understand. They illuminate whether the US stock markets are fundamentally-sound in the face of violently-aggressive Fed tightening, raging inflation, and a new recession.
These 25-largest US stocks dominating the American stock markets are all fantastic companies with great businesses. There’s no other way they could grow so massive. But being awesome doesn’t mean their underlying fundamentals justify their stock prices. While valuations are ignored in euphoric late-stage bull markets, bears’ ultimate sizes and durations are fueled by how expensive stocks remain during their maulings.
With these mighty American companies again commanding 42.2% of the SPX’s entire market cap, the concentration risk in these markets is staggering. The beloved top-five stocks alone represent 21.9% of this entire index, which is extreme! When they sneeze the entire US stock markets will catch a cold. And weakness is magnified in bear markets, with selling begetting selling scaring ever-more traders into capitulating.
The biggest US companies by far remain the mega-cap-tech market-darlings Apple, Microsoft, Alphabet, and Amazon. We all extensively use their products and services. Tesla’s meme-stock cult appeal has boosted it into the top five, but for many years that rank was held by Meta Platforms. Formerly Facebook, it has way more in common with the top four than Tesla. Meta recently changed its stock symbol from FB to META.
So for the purposes of this essay, I’m continuing the years-old precedent of considering AAPL, MSFT, GOOGL, AMZN, and META SPX-top-five while TSLA is relegated to the next-twenty-largest. While that is getting to be more of a stretch the longer and deeper Meta falls from grace, it is still mega-cap-tech while Tesla is a large manufacturer. Meta’s sales and profits remain far-bigger, more in line with the SPX-top-four.
The collective market caps of these 25-largest American companies shrunk 11.2% YoY by the end of Q2 to $14,430.7b. That slightly-outperformed the overall SPX falling 11.9% during that same span. But there were major composition changes with the US stock markets rolling over into a new bear. Fully six of the Q2’21 SPX-top-25 stocks fell out of these elite rankings during this past year, which is unusually-large.
Those included high-flying wildly-overvalued tech stocks like PayPal, Adobe, and Netflix. Despite their popularity, their revenues and earnings remained quite small relative to their inflated market caps. Those were mostly replaced by drug companies like Eli Lilly, Pfizer, AbbVie, and Merck which have way-bigger businesses. Oil supermajor Chevron also surged into the SPX top 25, sporting utterly-massive numbers.
Overall quarterly sales by these big US stocks soared 21.3% YoY to $1,106.3b. But about half those gains were due to those extensive composition changes. Among the 19 common SPX-top-25 stocks in both Q2’21 and Q2’22, revenues only grew 12.4% YoY to $940.4b. And the other oil supermajor Exxon Mobil proved a major driver, with its sales skyrocketing 70.8% YoY to $115.7b on the soaring crude-oil prices!
Excluding XOM as well as those six replaced big US stocks, overall revenues merely grew 7.3% YoY to $824.7b. And a big chunk of that is likely this raging inflation, as again the CPI averaged blistering 8.6%-YoY monthly growth last quarter. So adjusted for inflation, real sales by the largest American companies are likely flat at best. Customers are paying higher prices, but not necessarily buying more goods and services.
Mighty Apple has long held the crown as the largest US company, with people everywhere loving its products. Despite everyone always wanting the latest iPhones, Apple’s sales stalled last quarter merely edging up 1.9% YoY! In many ways Apple is an economic bellwether, since iPhones are so ubiquitous across this country and socioeconomic groups. Slowing sales imply Americans’ finances are getting pinched.
That mounting economic stress is also reflected in weaker US corporate earnings. Last quarter the SPX top 25’s overall profits plunged a brutal 34.8% YoY to $110.6b! Ominously those were the lowest seen since Q1’20, the quarter where COVID-19 lockdowns started. While raging inflation and slowing demand are definitely hitting earnings, these comparisons are heavily-skewed by investment giant Berkshire Hathaway.
Warren Buffett’s famous conglomerate is the sixth-largest SPX component, a colossal enterprise. Yet because it is a corporate holding company, it is forced to mark-to-market its investments each quarter. Accounting rules require unrealized gains and losses to be flushed through quarterly income statements, which makes Buffett’s blood boil like little else. He has spent long years railing against this huge distortion.
During Q2’21 when the SPX surged 8.2%, BRK reported unrealized “Investment and derivative contract gains” of $27.4b! But last quarter as the SPX plummeted 16.4%, BRK’s unrealized losses reported on that 10-Q line ballooned to a staggering $66.9b! While those can be backed out to see Berkshire’s real operating earnings, it’s easier just to exclude BRK’s crazy-volatile profits from both comparable quarters.
Ex-Berkshire, the SPX top 25 actually enjoyed modest earnings growth up 8.8% YoY to $154.0b. But again these are nominal numbers not adjusted for inflation. Assuming real-world inflation is as low as the CPI averaging 8.6% surges last quarter claims, these higher profits are a wash just like sales. They are actually looking worse than flat if those half-dozen companies shuffling in and out of these ranks are considered.
Without BRK and those six changing components over this past year, the core 18 SPX-top-25 stocks saw GAAP accounting earnings fall a rather-steep 8.0% YoY to $121.2b! And those were even really boosted by Exxon Mobil’s windfall profits that Democrats have often attacked. With quarterly-average crude-oil prices soaring 64.1% YoY to $108.58 in Q2’22, XOM’s earnings skyrocketed 288.5% YoY to a huge $18.6b!
Those are colossal Apple-level profits, rivaling that mega-cap tech’s $19.4b reported last quarter. But again in a troubling economic portent, those AAPL earnings fell 10.6% YoY. While Apple’s products are universally-loved, they are highly-discretionary. No one needs to upgrade their iPhones or iPads, they can make-do. Falling Apple profits may be revealing more Americans shifting budgets to buying necessities.
The overall earnings for those traditional SPX-top-five mega-cap-tech giants including Meta instead of Tesla plunged in Q2. They dropped a serious 24.1% YoY to $56.8b! For well over a decade, investors have rationalized the tech behemoths’ high valuations as being justified due to their strong profits growth. If that is vanishing, these gigantic stocks dominating the US stock markets’ fortunes are in for a nastier bear!
The managements running these greatest American companies love to plow cash into buying back their stocks. That artificially elevates both stock prices and earnings per share, maximizing executives’ huge salaries and bonuses. For many years corporate stock buybacks have been the single-largest source of US stock demand by far! So if they start nosing over and waning, this young bear could also grow way meaner.
Last quarter total stock buybacks among the SPX top 25 fell 10.0% YoY to just $76.2b. That wasn’t a one-off anomaly, but extended a contraction trend. Over the last three quarters including Q2’22, SPX-top-25 stock buybacks shrunk from $107.3b to $95.0b to just $76.2b! Since none of those six changing elite SPX components do big buybacks, they didn’t skew these numbers. Companies are feeling pinched too.
Stock buybacks must be financed by current profits or borrowing. With interest rates surging thanks to the Fed’s violent rate-hike cycle, the latter is getting far-more-expensive. So buyback campaigns will become increasingly dependent on quarterly earnings. And even these current reduced buyback levels generally aren’t sustainable given earnings trends. Many big US companies are spending far beyond their means!
Mighty Apple’s eye-popping $21.9b of stock buybacks last quarter despite flat sales and falling profits ran 112.5% of quarterly earnings! Add dividends and buybacks together, and that surged to 132.1%. There’s no way companies can sustain overspending on buybacks and dividends for long. Apple’s enormous cash hoard indeed plunged 21.8% YoY to just $48.2b at the end of Q2. It can’t do oversized buybacks forever.
And Apple wasn’t the only big US company pushing buyback limits. Cash-rich Microsoft, Alphabet, and Meta reported huge buybacks plus dividends running 80.0%, 95.0%, and 78.3% of their Q2 earnings. Plenty of other companies were way-crazier. NVIDIA, Walmart, Mastercard, Coca-Cola, and AbbVie stretched this metric to 123.4%, 187.9%, 125.6%, 135.2%, and 271.1% of their quarterly profits! That can’t last long.
With revenues flattening, profits shrinking, and borrowing costs soaring, this multi-decade stock-buyback gravy-train is careening towards a stark reality-check. While buybacks won’t end, odds are they will keep retreating on balance and prove considerably-smaller going forward. That too argues that this young bear market still has a long ways to run. Stock buybacks were the dominant force long keeping bears at bay.
But the most-damning thing about big US stocks’ Q2’22 results was these leading companies’ collective valuations in classic trailing-twelve-month price-to-earnings-ratio terms. Their overall P/Es did improve massively over this last year, plummeting 61.4% YoY to a 25.7x average as Q2 ended. That’s the job of bear markets, to maul stock prices sideways-to-lower long enough for earnings to catch up with stock prices.
The biggest problem for the US stock markets is 25.7x for 42.2% of the S&P 500 still remains seriously-overvalued. Historical fair-value over the past century-and-a-half or so is 14x earnings, which has a reciprocal earnings yield of 7.1%. That’s a fair return for investors deploying their scarce capital, and a fair price for companies paying to use it. Twice fair-value at 28x earnings is dangerous bubble territory.
Despite the S&P 500 rolling over into that young bear market last quarter, the big US stocks dominating the US stock markets still averaged near-bubble P/Es at 25.7x! Excessive valuations are the food feeding and sustaining bears, which generally don’t end until valuations mean-revert and overshoot back down to undervalued levels. That usually means sub-10x, although bear-slaying levels at half fair-value are closer to 7x.
If this young bear just prowls long enough to force SPX-top-25 valuations back down to 10x, the S&P 500 would have to plummet all the way near 1,475 at current earnings levels! That is a shocking 2/3rds below where it was trading mid-week. While predicting a bear that severe seems far-fetched, 50% losses in major bears are par-for-the-course. Such a drop from early January’s record high would need a 2,400 SPX.
That would still require US stock markets to plunge another 43.0% from current levels. The last couple major valuation-driven bears ending in October 2002 and March 2009 saw the SPX mauled 49.1% and 56.8% lower over 2.6 and 1.4 years! Bear markets are nothing to be trifled with, despite Wall Street denying them all the way down. Asset-gatherers and commission-takers need people to stay fully-invested.
Dividends are legitimate cash payouts to investors, not market-distorting gimmicks like stock buybacks. Last quarter SPX-top-25 dividends rocketed 41.9% higher YoY to $44.0b. That implies US companies are strong, since they need to have sufficient earnings and cash on hand to pay dividends. As cutting them back angers shareholders, dividends are treated very carefully. Unfortunately they too are really distorted.
Excluding those half-dozen composition-change companies from both quarters, the core big-US-stock SPX-top-25 dividends only climbed 5.8% YoY to $31.1b. The drug companies that replaced the high-flying techs in these elite ranks over this past year pay much-fatter dividends. Far more so than slowing stock buybacks, when dividends start falling among big US stocks we’ll know they are facing serious pressure.
SPX-top-25 operating cashflows generated last quarter excluding the huge money-center banks looked healthy up 11.3% YoY to $183.3b. JPMorgan Chase’s and Bank of America’s OCFs are far-too-volatile to ever consider. But unfortunately those better cashflows resulted from those six component changes and XOM’s epic oil-driven windfall. Removing those from both quarters leaves OCFs sliding 8.6% YoY to $128.5b!
With this challenging economic environment impairing big US companies’ abilities to generate strong operating cashflows, their overall cash treasuries also weakened during this past year. At the end of Q2’22, the SPX top 25 collectively reported $747.7b in cash and marketable securities on their books. That fell a sharp 17.0% YoY! Elite American companies are increasingly burning through cash to keep up appearances.
Without those half-dozen component changes, the overall falling-cash picture looks similar with a 14.6%-YoY decline to $710.9b for the rest of these SPX-top-25 companies. Just like households, managements running businesses increasingly worry as their cash balances dwindle. In order to preserve those essential buffers in a recessionary economy, companies will ramp up laying off employees and cutting stock buybacks.
So overall the big US stocks’ latest fundamentals don’t look great considering today’s challenging bear-market, raging-inflation, and recessionary environment. That argues this young bear has a long ways to run yet before giving up its ghost. Investors should pare their stock-heavy portfolios before it deepens. Gold, silver, and their miners’ stocks are the classic alternative investments that thrive in general-stock bears.
This gold complex does even better during inflationary times. As raging inflation erodes corporate profits weakening stock prices, gold investment demand for prudent portfolio diversification soars. During the last similar inflation super-spikes in the 1970s, gold prices nearly tripled during the first and more than quadrupled in the second! Gold also thrived during past Fed-rate-hike cycles, which are bearish for stock markets.
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The bottom line is the big US stocks’ latest quarterly results exacerbated the risks this young bear market is far from hibernating. These elite American companies’ revenues largely stalled when adjusted for this raging inflation. And their nominal earnings actually fell as struggling consumers pull back discretionary spending. That left average valuations way up near dangerous bubble territory despite falling stock prices.
Excessive valuations are the food that ravenous bears devour, lingering until they are mauled back down to undervalued levels. A normal bear mean-reversion and overshoot would warn the majority of this young bear is still yet to come. And corporate stock buybacks’ ability to stave it off is waning as they retreat. So it would be prudent for investors to pare their heavy stock holdings and redeploy some of that capital in gold.
Adam Hamilton, CPA