When Jessica and I were assembling the topics for tonight’s note at 10am this morning the world was a very different place from where it stands at 9pm tonight. President Trump’s afternoon tweets that seem to threaten a new phase of trade war with China are the difference, of course.
The silver lining for our purposes: it gives us a chance to bring today’s valuation discussion to a real-world conclusion in this last section.Predictability, we noted in the Markets section, is the enabler of lofty equity valuations. Surprise announcements on social media about trade talks gone wrong don’t fit anyone’s idea of “predictable”. What the goldilocks Jobs Report on Friday giveth, Twitter and trade taketh away. Or so it seems.
The sector to watch tomorrow, for reasons we will outline here, is Technology. Four reasons why:
#1: Tech is one of the few S&P sectors with +50% non-US revenues and profits. The exact number is 58% non-US sales, the highest of any industry group. That makes it the poster child for international trade, and not just with China. Markets were hoping that a calm resolution to US-China trade disputes would pave the way for other agreements.
All that may still come to pass, but US large cap Tech is uniquely exposed to this narrative. And not in a good way, obviously.
#2: The large cap Tech sector is almost twice as profitable as the average S&P 500 company. Net margins in Q1 2019 were 20.8% versus an estimated 11.0% for the index as a whole. That means those non-US revenues from the prior point carry through to the bottom line at double the rate of incremental revenues for most other industry groups.
#3: Remember that “Tech” in S&P sector-land doesn’t include Facebook/Google (banned in China), or Amazon (no real presence) so what remains – Apple and Microsoft, for example – have outsized direct China exposure.
#4: At a 21.7% weighting in the S&P 500, Tech’s premium earnings multiple of 19.3x forward earnings was an outsized reason US stocks sported a 16.8x earnings multiple on Friday evening. Where they settle out on Monday evening remains to be seen…
The bottom line here is one we highlight whenever a sudden selloff hits US stocks: there’s always one sector to watch for signs that the fear has hit a crescendo, and this time it is Technology. It is the fulcrum asset from both a fundamental perspective (high non-US revenues, margins) and in terms of market valuations (high multiples). When Tech bottoms, the market bottoms. And not before.