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Time For A Breather?

Someone Should Tell Tech Stocks It’s Not 2021
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Time For A Breather?

Someone Should Tell Tech Stocks It's Not 2021

Hi Everyone 👋,

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The YTD Tech run has been nothing short of remarkable.

Despite a pending recession, tight monetary policy, and slowing global growth, Tech has rallied hard.

FANG+ (extended technology index of 10 names) neared its 2021 high last week.

Remember though, 2021 was a period of MASSIVE monetary stimulus and we have the exact opposite conditions right now.

Many have attributed this rally to the AI hype cycle and highlight how narrow market breadth is.

Will this growth-fueled rally extend to the rest of the market?

Let’s take a look at just how narrow this rally has been.

This week, in <5 minutes, we’ll cover:

  • What’s in A “Stock Price”? 👉 Fundamental x Sentimental

  • Select Stock Performance 👉 Price Action – Fundamentals or Multiple Expansion?

  • Narrow Leadership 👉 A Look at the Rest of the Market

  • No One Saw This Coming 👉 Outlooks From Last Year + Hedge Fund Performance

Let’s get started!

1. What’s in A “Stock Price”? 👉 Fundamental x Sentimental

There are two things that make up a stock price: Fundamentals and Sentimentals. Fundamentals are things like sales, net income, EPS, EBITDA, etc. Sentimentals is the “multiple” to which the fundamentals trade. Fundamental x Sentimental = Stock Price.

When market rallies are driven by improving fundamentals, they move slowly up and to the right. This is why people love owning stocks. They are participating in the growth of companies and the economy.

On the flip side, market rallies fueled by multiple expansion mean euphoria. We have that in SPADES right now around AI…

When the Fed raises rates, Tech should get smacked. They are considered long duration assets. Most of their cash flows are expected to be generated in the future vs now.

Don’t forget, cash flows are always more valuable now vs tomorrow, because they are discounted by the cost of capital. The cost of capital is impacted by the Fed. As rates go up, the tone of the market gets more difficult, funding dries up and future cash flows are worth less. That’s the math in the face of Tech, so seeing this rally is surprising.

While the Fed has been the driver of market swings over the pandemic era, we’ve also seen hype around hot and new technologies.

Remember when everyone was adding “blockchain” to their name and attracting big bucks?

For frequent readers, this will sound familiar. I always say that studying social behavior and history is as important as understanding financials.

People like stories and latch onto narratives when forming investment theses.

The new narrative is AI and Tech is defying the Fed.

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2. Select Stock Performance 👉 Price Action – Fundamentals or Multiple Expansion?

Let’s start with the company everyone is talking about- Nvidia. I did a deep dive for paid subscribers on Nvidia back in February of 2023 that you can find here.

When people see a gold rush, it's always smart to bet on the guy selling picks and shovels. That's Nvidia. If we look at its 5-year chart, there’s a Bitcoin-like elevator up.

Cue the rocket emoji.

Now, let’s overlay this chart with the EV/Sales multiple, the EV/EBITDA multiple and zoom in on a more recent time frame:

In the early stages of the rally, a majority of the stock’s price performance can be attributed to multiple expansion.

But something then changed. Check out the big elevator down in the green and yellow lines near the end of the chart.

That's Nvidia's earnings quarter.

They had one of the biggest one-quarter estimate revisions in history. For you market historians out there, send me an email if you can find a bigger one. I’m very curious to see.

The day before earnings, Nvidia had a market cap of $755 B. Just one day later, it hit $940 B. Now, the company is up 193% YTD. That one day gain of $185 B is bigger than the market caps of Nike, Comcast, Disney and Netflix.

Their fiscal 2Q24 (which is the next quarter because they have an April year-end) revenue forecast of $11B was 55% above consensus estimates. It looks like the strength of its data center products and increasing spending on generative AI could make them a lot of money.

They're also coming out of an inventory correction on both the auto and gaming businesses. Gross margin upside to 70% is also expected through an improved mix and higher data center revenue contribution.

With all this good news, management steeply revised revenue, gross margins and EBITDA margins forecasts. Over the next few quarters, their EBITDA margin is expected to be in the high 50%’s.

There’s been a jump in both fundamentals and sentimentals (multiples), but what about the rest of the Tech companies?

The rally wasn’t just Nvidia. The Megacaps also joined in.

Some call it seller fatigue, but I call it buyer laziness. Investors are running back to what worked for the past two decades: Megacap Tech.

Is no one paying attention to interest rates?

3. Narrow Leadership 👉 A Look at the Rest of the Market

If you want to see just how narrow market breadth is, check out equal weighted indices vs. market-cap weighted indices. This helps highlight market breadth, because you can strip out the impact of size on market performance. It’s especially helpful now because the biggest stocks right now are mostly tech companies.

Check out the equal weighted S&P vs. the super tech heavy QQQ:

Here, I’ve pulled a ratio of QQQ/SPW. This shows QQQ beating out the equally-weighted S&P.

There's been a HUGE comeback in relative performance dating back to 2021. Back then though, monetary stimulus was fueling the tech craze.

Let’s zoom out to see if this reminds us of any other time periods…

Things aren’t as extreme as the dot-com bubble, but we’re not that far off.

The 2000-2019 slow grind up was primarily due to: 1) The “growing up” of Tech businesses into recurring revenue, high margin companies and, 2) Low interest rates.

Factor 1 remains, Factor 2… no so much.

4. No One Saw This Coming 👉 Outlooks From Last Year + Hedge Fund Performance

I believe what's catching most people off guard is that nobody anticipated this.

If we review the forecasts for 2023, the consensus was that the "real economy" would outperform, Canada's stock market (which is heavily reliant on resources and financials) would excel, and the NASDAQ would face difficulties.

Then the AI hype took off.

When you talk about unexpected events, there’s a pretty good proxy for what is “expected” vs what the “experts” are doing in the field. You guessed it – the hedge funds.

According to Goldman's analysis of the holdings of 740 hedge funds with $2.2 trillion in gross equity positions at the beginning of the second quarter:

On average, equity hedge funds returned 3% year-to-date, compared to the S&P's 7% increase and the QQQ's 20.5% surge. Tech emerged as the winner.

The analysis reveals that hedge funds shifted their focus towards defensive sectors such as Health Care, Consumer Staples, and Utilities, and they were gravely mistaken.

That turn of events caught them completely off guard…

Wrapping Up…

To me, it seems like tech stocks are in desperate need of a breather after this run. Although… I've also believed that Canadian housing would decline over the past year. That's a discussion for another time…

My lesson here is that it's tough to bet against winners, and you need to sharpen your pencils when analyzing fundamentals.

This will make the upcoming earnings period extremely important as we observe what will actually materialize in profits.

Buckle up…

Until next time. Always Yours. Incessantly Chasing ROI,

-Genevieve Roch-Decter, CFA

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Disclaimer:The publisher does not guarantee the accuracy or completeness of the information provided in this page.  All statements and expressions herein are the sole opinion of the author or paid advertiser.

Grit Capital Corporation is a publisher of financial information, not an investment advisor.  We do not provide personalized or individualized investment advice or information that is tailored to the needs of any particular recipient.  

THE INFORMATION CONTAINED ON THIS WEBSITE IS NOT AND SHOULD NOT BE CONSTRUED AS INVESTMENT ADVICE, AND DOES NOT PURPORT TO BE AND DOES NOT EXPRESS ANY OPINION AS TO THE PRICE AT WHICH THE SECURITIES OF ANY COMPANY MAY TRADE AT ANY TIME.  THE INFORMATION AND OPINIONS PROVIDED HEREIN SHOULD NOT BE TAKEN AS SPECIFIC ADVICE ON THE MERITS OF ANY INVESTMENT DECISION.  INVESTORS SHOULD MAKE THEIR OWN INVESTIGATION AND DECISIONS REGARDING THE PROSPECTS OF ANY COMPANY DISCUSSED HEREIN BASED ON SUCH INVESTORS’ OWN REVIEW OF PUBLICLY AVAILABLE INFORMATION AND SHOULD NOT RELY ON THE INFORMATION CONTAINED HEREIN.

No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer or the solicitation of an offer to buy or sell the securities or financial instruments mentioned.  

Any projections, market outlooks or estimates herein are forward looking statements and are inherently unreliable.  They are based upon certain assumptions and should not be construed to be indicative of the actual events that will occur.  Other events that were not taken into account may occur and may significantly affect the returns or performance of the securities discussed herein.  The information provided herein is based on matters as they exist as of the date of preparation and not as of any future date, and the publisher undertakes no obligation to correct, update or revise the information in this document or to otherwise provide any additional material.

The publisher, its affiliates, and clients of the a publisher or its affiliates may currently have long or short positions in the securities of the companies mentioned herein, or may have such a position in the future (and therefore may profit from fluctuations in the trading price of the securities).  To the extent such persons do have such positions, there is no guarantee that such persons will maintain such positions.

Neither the publisher nor any of its affiliates accepts any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of the information contained herein.

By using the Site or any affiliated social media account, you are indicating your consent and agreement to this disclaimer and our terms of use. Unauthorized reproduction of this newsletter or its contents by photocopy, facsimile or any other means is illegal and punishable by law.

For Full Terms of Use Click HERE. For the Privacy Policy Click HERE.

Gritcapital.substack.com (“Grit”) is a website owned and operated by Substack. Grit is paid fees by the companies that make investment offerings on this website. Be aware that payment of these fees may put Grit in a conflict of interest with the investor. By accessing this website or any page thereof, you agree to be bound by the Terms of Use and Privacy Policy, in effect at the time you access this website or any page thereof. The Terms of Use and Privacy Policy may be amended from time to time. Nothing on this website shall constitute an offer to sell, or a solicitation of an offer to buy or subscribe for, any securities to any person in any jurisdiction where such an offer or solicitation is against the law or to anyone to whom it is unlawful to make such offer or solicitation. Grit is not an underwriter, broker-dealer, Title III crowdfunding portal or a valuation service and does not engage in any activities requiring any such registration. Grit does not provide advice on investments or structure transactions. Offerings made under Regulation A under the U.S. Securities Act of 1933, as amended (the “Securities Act”) are available to U.S. investors who are “accredited investors” as defined by Rule 501 of Regulation D under the Securities Act well as non-accredited investors, who are subject to certain investment limitations as set forth in Regulation A under the Securities Act. In order to invest in Regulation A offerings, investors may be asked to fill out a certification and provide necessary documentation as proof of your income and/or net worth to verify that you are qualified to invest in offerings posted on this website. All securities listed on this site are being offered by, and all information included on this site is the responsibility of, the applicable issuer of such securities. Grit does not verify the adequacy, accuracy or completeness of any information. Neither Grit nor any of its officers, directors, agents and employees makes any warranty, express or implied, of any kind whatsoever related to the adequacy, accuracy, valuations of securities or completeness of any information on this site or the use of information on this site. Neither Grit nor any of its directors, officers, employees, representatives, affiliates or agents shall have any liability whatsoever arising from any error or incompleteness of fact, or lack of care in the preparation of, any of the materials posted on this website. Investing in securities, especially those issued by start-up companies, involves substantial risk. investors should be able to bear the loss of their entire investment and should make their own determination of whether or not to make any investment based on their own independent evaluation and analysis.