Amazon is believed to be the driving force behind the 39% share of all e-commerce sales in the US. Photo: AFP

Slowly but steadily coronavirus is becoming a thing of the past. Countries are easing quarantine measures and opening their economies. Meanwhile, stock markets are rebounding with the technology-heavy Nasdaq reaching all-time highs.

Some believe that investors have been encouraged by the promise of a rapid rebound as soon as 2021. Others suggest it was due to the greed and the fear of missing out (FOMO), citing the example of Bitcoin at the end of 2017. From November 12 to December 16, the price of the digital coin grew over 240% and hit nearly $20,000, but after that fell over 65% (back to $6000) in one month and a half. Its dominance, on the other hand, fell from 71% to 36.52% from December 17 2017 to January 14, 2018.

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In order to understand if the situation is similar to the stock market, it is important to analyze the reasons behind the recent rally. 

https://www.isabelnet.com/share-of-sp-500s-total-market-value-five-biggest-stocks/

First thing first, according to The Wall Street Journal, the FAANG stocks — Facebook, Amazon, Apple, Netflix, and Alphabet– since March 16 of this year, grew 62.08%, 56.73%, 45.68%, 45.39% and 36.51% correspondingly. The market capitalization of the five largest companies now accounts for 20.4% of the S&P 500 total and has nearly doubled since 2013.

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It might appear at first sight that we have yet another bubble. But we are here to analyze not just assume.

Amazon

Due to the mandatory quarantine, consumers had to rely more on online shopping, social media use, teleconferencing, and streaming of videos and movies. 

According to the European Parliamentary Research Service, online marketplaces currently account for 56% of online sales and will attain 67% of global e-commerce sales by 2022. The main e-commerce marketplace players are Chinese (Taobao, Alibaba, JD.com) or American (Amazon, eBay). Amazon is believed to be the driving force behind the 39% share of all e-commerce sales in the US. It has surpassed Walmart as the world’s largest retailer.

A similar trend is observed in cashless payments, on-demand delivery services related to fresh produce, online education, and social engagement platforms from gaming to OTT platforms, online collaborative tools, e-pharmacies, cloud computing, and even online consultations.

Overall, the coronavirus crisis has increased digitization in the supply chain. Eventually, it will remove some of the inefficiencies that exist and at the same time add value for retailers.

Facebook

In the case of Facebook, according to its Q1 Earnings Call Transcript, for the first time ever, over 3 billion people are actively using Facebook, Instagram, WhatsApp or Messenger each month. All over the world, the messaging volume has increased, as well as voice and video calling. Most importantly, despite the coronavirus outbreak, their total ad revenue for Q1 was $17.4 billion, which is a 17% year-over-year increase. The company also registered strong growth in gaming and relative stability in technology and e-commerce. 

https://investor.fb.com/investor-news/press-release-details/2020/Facebook-Reports-First-Quarter-2020-Results/default.aspx

It is worth mentioning, that Facebook’s revenue was strong from the beginning of the quarter through the first week of March, when they began to see a steep slowdown in their ads business, particularly in countries that implemented quarantine measures to reduce the spread of the virus. As a result, the company lowered ad prices due to the overall reduction in publicity demand, thus trying to keep as many advertisers as possible. These trends have continued into Q2.

This is why the company declined to provide any specific revenue guidance for the following quarter or full year 2020. So far, ad revenue has been approximately flat compared to the same period a year ago, down from the 17% year-over-year growth in the first quarter of 2020. Even though, Facebook continues to grow its Capex investments. In 2020, they expect capital expenditures to be approximately $14 billion to $16 billion, down from our prior range of $17 billion to $19 billion. The bad debt expense, on the other hand, increased by $193 million.

Consider that the advertising industry tends to go down when there are big GDP corrections. So the advertising industry pretty much undoubtedly is going to go down. It is expected that Facebook will focus more on e-commerce. 

That raises the question, why did the stock grow over 13% YTD then? First, it is important to highlight that Facebook repurchased $1,2 billion of its Class A common stock. Second, people believe that Facebook Shops and Instagram Shops will expand the company’s revenue stream beyond advertising.

Apple

The stock of the company has also drastically increased this year – over 14% YTD. And that is despite the fact that smartphone demand has weakened due to Covid-19. Even though, over the last 5 quarters, Apple Inc.’s profits have increased from $11.73 to $12.75 in March 2020. Earnings forecasts for the company have been increasing, suggesting an improvement in future earnings growth. 

The revenue for the quarter was $58.3 billion, up 1% from a year ago, despite the extreme circumstances from the impact of Covid-19. Product revenue was $45 billion, down 3%. iPhone revenue of $29 billion declined 7% year-over-year.

In terms of services, the company set an all-time revenue record of $13.3 billion. Strong performance has been registered across the App Store, Apple Music, video, cloud services, and App Store search ad business. And they also set a March quarter record for Apple Care. Apple TV+, Apple Arcade, Apple News+ and Apple Card, continued to add users, content, and features. 

Wearables, Home and Accessories recorded a revenue of $6.3 billion, up 23% year-over-year, with strong double-digit performance across all five geographic segments. 

Nevertheless, the company expects iPhone and Wearables business revenues for the fiscal second quarter to be worse on a year-over-year basis than the fiscal first quarter. On the contrary, iPad and Mac revenues are expected to improve but problems in the world economy could negatively affect AppleCare and advertising businesses. The company didn’t provide any guidance due to the uncertainty.

Either way, Apple still has a pretty strong balance sheet and generates significant cash flow. They ended the quarter with $193 billion in cash plus marketable securities, the total debt of $110 billion, and as a result, net cash was $83 billion at the end of the quarter. They returned $22 billion to shareholders during the March quarter, including $18.5 billion through open market repurchases of 64.7 million Apple shares and $3.4 billion in dividends and equivalents.

Total debt-to-total capital of 55.9% is better than the industry’s 58.7%. In addition, Apple generated operating cash flow increased $2.2 billion to $13.3 billion in the fiscal second quarter. The company also increased its quarterly dividend by 6%. 

https://www.apple.com/newsroom/2020/04/apple-reports-second-quarter-results/

It could be a moment to keep an eye on its attempt to push 5G penetration. From June 1, Apple products will be included for the first time in China’s 6.18 annual online shopping festival, with important discounts across all iPhone product lines. It will be interesting to see how it goes for them as the company faces serious competition, especially in the case of tablets from Amazon, HTC, Microsoft, and HP. In the case of the wearables market, it would be Xiaomi, Fitbit, Huawei, and Samsung.

Finally, yet importantly, the Supreme Court has allowed the consumers’ antitrust lawsuit against Apple to continue in a lower court. We shouldn’t also forget a record fine of €1.1 billion by French anti-trust regulators for engaging in anti-competitive practices. 

A similar situation can be observed in Alphabet, Microsoft, and Netflix, but what about the rest of the stock market? The chart below shows that US stocks have surged even as profits have drastically fallen. The uncertainty has required many companies to preserve cash by suspending dividends and share buybacks, among other steps.

At the end of April, according to WSJ, 83 US companies and public investment funds, like real-estate investment trusts, have suspended or canceled their dividends, the highest number in data going back to 2001. In the previous 10 years, 55 companies eliminated their dividends. An additional 142 companies have reduced their payouts to shareholders in 2020, on pace for the worst year since 2009 when there were 316 such cuts. 

https://www.isabelnet.com/corporate-profits-after-tax-vs-sp-500/

It is true that some companies actually have raised their payouts, including medical device maker Medtronic, PepsiCo, Clorox, Cardinal Health, Chubb, Expeditors International of Washington, 3M, Abbott Laboratories, AbbVie, Amcor PLC., etc. The full list can be found here.

The question then must be raised, why is the rest of the stock market booming?

Over the last few months, the Fed adopted a series of expansive programs to boost the economy and, most importantly, prop-up the financial markets after the sudden fall. In addition to lowering short-term interest rates to almost zero, thus decreasing the borrowing costs for banks, the Fed has also cut bank reserve requirements and launched asset-purchase programs, aka quantitative easing. 

Just in case, let’s remind that QE involves the Fed’s purchase of Treasury bonds and other government-guaranteed debt from commercial banks in order to pump money into the banking system. The main purpose is to stabilize the banking system during times of stress. In addition, it provides commercial banks with much needed liquidity so they can make more loans to consumers and businesses with the objective of stimulating economic growth.

On the other side, QE triggers artificial demand for the purchased assets, thus increasing their market price and in some cases lowering interest yield. The same thing happens to the price of financial markets. For example, when the Fed purchases Treasury bonds and agency debt from commercial banks in exchange for dollars, this increases the amount of cash on each bank’s balance sheet. As a result, QE programs may trigger artificial price increases in financial markets, creating bubbles.

In the second half of March, the Fed announced open-ended and unlimited QE. In particular, the Federal Open Market Committee (FOMC) began purchasing Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy. The FOMC had previously announced it would purchase at least $500 billion of Treasury securities and at least $200 billion of mortgage-backed securities. Besides that, the FOMC included purchases of agency commercial mortgage-backed securities in its agency mortgage-backed security purchases.

In a related set of actions, the Federal Reserve announced additional measures to support the flow of credit to households and businesses:

  • Establishment of a third facility, the Term Asset-Backed Securities Loan Facility (TALF), to support the flow of credit to consumers and businesses. 
  • Facilitating the flow of credit to municipalities by expanding the Money Market Mutual Fund Liquidity Facility (MMLF) to include a wider range of securities, including municipal variable rate demand notes (VRDNs) and bank certificates of deposit.
  • Facilitating the flow of credit to municipalities by expanding the Commercial Paper Funding Facility (CPFF) to include high-quality, tax-exempt commercial paper as eligible securities.

In the image below, we can see the change between the Nasdaq 100 (Orange Line), Federal Government Debt (Sky Blue line), Total assets (Blue line), and Gold (Green line). The QE effect is clear. 

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The problem here is that by purchasing corporate bonds and other risk assets in the primary and secondary markets, the Fed takes the role of determining corporate winners and losers. Additionally, it provides an implicit promise by the federal government to support market prices in times of crisis. 

Finally, yet importantly, the Fed caused a rush into corporate bonds, pooling risk in an unstable asset. Low-interest rates, on the other hand, triggered growth in the number of zombie firms (that are unable to cover debt serving costs from current profits over an extended period). Indebted companies try to avoid liquidation by firing workers, but even that doesn’t always work. 

https://www.bis.org/publ/qtrpdf/r_qt1809g.pdf

Igor Kuchma

Igor Kuchma is a financial adviser who is passionate about economy and the capital markets in general. He has experience working with Russian, Spanish and American financial institutions. He helped to compile a course for the Series 7 exam, while some companies he has prepared investment portfolios and macro and microeconomic models in Excel, and has studied trends and historical data.