The mighty and long-impervious US stock markets have suffered a major trend reversal this year, rolling over into a full-blown correction. Volatility has exploded with the Fed’s epic monetary spigots being shut, inflation raging out of control, and a new Fed-rate-hike cycle looming. This ominous seriously-challenging backdrop for stocks leaves underlying fundamentals from their latest earnings season important to understand.
The US Securities and Exchange Commission requires publicly-traded companies to report how their businesses are faring after each quarter. Normal 10-Q forms are due 40 calendar days after quarter-ends. But the far-more-comprehensive 10-K annual reports covering entire years have a more-relaxed 60-calendar-day deadline after Q4s. So US companies’ newest Q4’21 earnings season just wrapped up.
Last quarter proved a landmark one for the big US stocks that dominate the flagship S&P 500 benchmark stock index, or SPX. It soared a massive 10.6% in Q4 alone, achieving 16 new all-time-record closing highs! That capped a stupendous 2021 where the SPX rocketed up another 26.9%. So last quarter sure looked like the best of times for large-cap US stocks. Complacent investors didn’t have a care in the world.
But as all contrarians know, the times to be afraid are when others are brave. The SPX climbed a little further to another record 4,796.6 close on 2022’s first trading day, but has mostly plunged ever since. That started after minutes from the Federal Open Market Committee’s mid-December meeting revealed top Fed officials were discussing soon starting quantitative tightening, reversing the Fed’s extreme money printing.
The vast torrents of new money conjured out of thin air by quantitative easing had levitated the US stock markets for years. By late December, the Fed’s balance sheet had ballooned an eye-popping 110.6% or $4,599b in just 22.1 months since March 2020’s pandemic-lockdown stock panic! It was no coincidence the SPX skyrocketed a nearly-identical 114.2% over that same span. Vast Fed money printing forced stocks higher.
So the Fed pulling away its easy-money punch bowl was a dire omen for QE4-goosed stocks. Indeed the SPX quickly rolled over into a correction-grade selloff, plunging 13.0% at worst so far on a closing basis in Q1’22! While Russia invading Ukraine and destroying its cities certainly exacerbated that selloff, realize nearly 3/4ths of it had already happened before Russian armor initially rolled across Ukraine’s borders.
Fed QT and Fed rate hikes are far-more-serious threats to US stock markets than this terrible geopolitical nightmare. So seeing how big US companies were faring in Q4 before the Fed’s monetary regime shifted from hyper-easing to imminent tightening is very important for all investors. Soon after each quarterly earnings season I dig into the latest results reported by the 25-largest US companies dominating the SPX.
At the end of Q4, these behemoths collectively accounted for a staggering 43.3% of this benchmark’s total market capitalization! That was the highest seen in the 18 quarters I’ve been advancing this deep-research thread, revealing high concentration risk. All American investors have big exposure to these giants, especially those holding the colossal SPY SPDR, IVV iShares Core, or VOO Vanguard S&P 500 ETFs.
These are the largest exchange-traded funds in the world, still commanding $950b of capital this week even after the SPX’s sharp Q1 plunge! Over the last couple weeks I’ve analyzed the 25 biggest US stocks’ latest 10-K or 10-Q reports, the latter being from companies with fiscal years offset from calendar ones. A bunch of data from those results was fed into a giant spreadsheet, with highlights shown 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 Q4’20. These symbols are followed by their stocks’ Q4’21 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 Q4’21 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 lofty US stock markets were fundamentally-sound at those latest SPX record highs, and whether the selloff since is justified.
Without a doubt, these 25-biggest US stocks are all fantastic companies. Investors flocked to them for good reason during 2021, as their 29.9%-YoY collective market-cap gains bested the SPX’s 26.9% surge higher in that span. But that left their enormous $18.6t total market capitalizations commanding a major 43.3% of the entire S&P 500! Again that’s the most concentration in at least the last 18 quarters, maybe ever.
The elite mega-cap technology companies, normally the five-largest US stocks, remain in an amazing league of their own. They are of course mighty Apple, Microsoft, Alphabet (Google), Amazon, and Meta (Facebook). The extreme mania buying of Tesla stock temporarily displaced Meta, but that electric-car maker doesn’t belong in those rarefied ranks in fundamental terms. Tesla’s sales and profits are far smaller.
Thus in this essay the mega-cap techs refer to those usual top-five US companies including Meta but not Tesla. The latter is instead included with its normal positioning in the next-20-largest US stocks. Further breaking down the latest quarterly results between these two disparate groups remains illuminating. The mega-cap techs’ average market cap hit a staggering $2,016b, dwarfing the next 20 largest averaging just $426b!
As the SPX marched to that long parade of new record highs last quarter, the SPX top 25’s collective sales growth remained phenomenal. It’s hard to imagine companies operating at these vast scales being able to boost top-line revenues 8.4% YoY to $988b! But that is bifurcated, with the mega-cap techs’ sales up a blistering 15.6% YoY while the next-20-largest US stocks only saw comparatively-small 3.6% YoY growth.
Naturally with bigger revenues came much-bigger earnings. This entire market-dominating group of elite stocks saw hard GAAP profits reported to the SEC soar a staggering 25.0% YoY to $202b! That proved the highest seen by far in the last 18 quarters, and probably ever. Usually the mega-cap techs account for most of this growth, but that wasn’t the case in Q4’21. Their earnings soared 26.7% YoY near $99b!
Yet the rest of the SPX top 25 enjoyed a similar 23.4%-YoY profits surge over $103b. Tesla and the computer-graphics-card manufacturer NVIDIA led the way, achieving outstanding 760%-YoY and 106%-YoY earnings growth. The COVID-19-vaccine makers are also earning money hand over fist from mandates, with Johnson & Johnson and Pfizer enjoying colossal 172% and 471% profits surges over this past year.
Since the Pfizer COVID-19 shots became the ones of choice in 2021, that company’s revenues soared an astounding 297% YoY in Q4! That windfall change in this company’s fortunes is why it is pushing so hard for entire populations to submit to booster shots forever. The epic healthcare spending surrounding COVID-19 also greatly boosted health-insurance-giant UnitedHealth’s earnings too, which soared 84% YoY.
Despite these big profits wins, the largest US companies’ overall earnings picture is misleading due to legendary investor Warren Buffett’s famous conglomerate. Often the largest US stock after the mega-cap techs, Berkshire Hathaway is an investment holding company operating at a colossal scale. One thing that Buffett often rails against is accounting rules requiring investments to be marked-to-market each quarter.
That means unrealized gains and losses in investment holdings must be run through income statements, which heavily distorts earnings when stock markets are really moving. Berkshire reported net profits of $39.6b in Q4’21, even bigger than Apple’s $34.6b. Yet the former included fully $40.5b of investment gains, meaning Berkshire’s extensive stable of operating companies actually lost $0.9b in that best of quarters!
Those were driven by that major 10.6% SPX surge higher in Q4. But again so far in this current Q1’22, the SPX has plunged a similar 10.2%. So Berkshire’s huge unrealized gains are going to turn into huge unrealized losses, hammering its profits deeply negative and making Buffett’s blood boil. Fully 1/5th of last quarter’s huge SPX-top-25 earnings came from Berkshire’s mark-to-market gains, which aren’t real profits.
All these earnings numbers are absolute bottom-line results, not the earnings per share that are so easily manipulated by stock buybacks. Repurchasing stocks reduces the number of shares outstanding, which spreads total profits over fewer shares boosting EPS. Plenty of US companies have come under fire in recent years for managing to engineer misleading solid EPS growth despite suffering declining total profits.
With the FOMC holding its federal-funds rate near zero in Q4 while Fed officials increasingly predicted a looming rate-hike cycle, the big US companies rushed to unleash staggering stock buybacks. For the SPX-top-25 companies, those skyrocketed 74.8% YoY to over $107b! That’s the primary reason these stocks’ prices and thus the entire S&P 500 were so strong last quarter. Such vast levels aren’t sustainable.
The Fed’s artificial ZIRP environment has enabled big companies to borrow huge amounts of money at super-low interest rates to buy back their stocks. But ultimately stock buybacks have to retreat well below corporate profits less dividends paid. Big US companies need to reinvest some sizable-to-large fraction of their earnings in growing their underlying businesses. Higher rates will heavily retard stock buybacks.
The two biggest buybacks last quarter came from Apple and Meta. The former could certainly afford the $20.5b it plowed into bidding up its own stock, as that was just 0.59x of its Q4 earnings. But it was odd to see Apple cut its buybacks 17% YoY despite 20%-YoY profits growth. Does this giant smartphone maker fear a slowing economy? Is its vast cash hoard dwindling too fast? Is this a nothingburger timing issue?
The company formerly known as Facebook spent a similar $20.1b last quarter to actively manipulate its flagging stock price higher. Yet that was an absurd 1.95x its entire Q4 profits! Meta ramped its stock buybacks by a breathtaking 941% YoY, while its corporate earnings dropped over 8%. While Berkshire suffered that $0.9b operating loss without those investment gains, it still allocated $6.9b in cash to buybacks.
If you compare the SPX-top-25 companies’ earnings with their buybacks in this table, there are actually a surprising number with stock repurchases exceeding profits. That can’t last, and the Fed’s imminent new rate-hike cycle forcing corporate borrowing rates higher will increasingly slow this stock-buyback frenzy. That means it will be much harder for the S&P 500 to keep powering higher on balance going forward.
Now if our fundamental analysis stopped at the big US stocks’ phenomenal revenues and earnings, it would be easy to assume record-high stock prices were totally-righteous. But an essential part of fundamentals is how much investors are being asked to pay for underlying profits streams. How expensive or cheap stocks really are is only evident when comparing their prices to their earnings, through TTM P/E ratios.
TTM of course means trailing-twelve-month, the last four quarters of actual reported earnings. Because valuations measured by these traditional P/Es have been so darned high thanks to the Fed’s mammoth monetary bubble, Wall Street has long sought to mask these by using fictional forward P/Es instead. But those are fantasy, based on analysts’ estimates of future profits which nearly always prove way-too-optimistic.
Exiting Q4’21 with the flagship S&P 500 right at record highs, its top-25 companies averaged staggering TTM P/Es of 53.3x! If an investor bought those shares then, at current profits levels it would take over 53 years for companies to earn back the prices paid for their stocks. While that did plunge an impressive 45% YoY largely thanks to Tesla’s radical overvaluation collapsing 74%, 53.3x remains dangerously-high.
For the past century-and-a-half or so, fair-value for the US stock markets has averaged 14x earnings. That makes sense, as the reciprocal of that implies a 7.1% annual profits return for investors. That is a mutually-advantageous rate for both investors to earn by supplying their surplus capital to companies and for those companies to pay for using it. Twice that historical fair-value at 28x earnings is where bubbles start.
At 53.3x, US-stock-market valuations were deep into bubble territory exiting Q4! But that average TTM P/E of the SPX-top-25 stocks is skewed high by Tesla’s ridiculous 348.3x valuation bestowed by its cult-like following of true believers. Disney’s lofty 142.5x P/E was also an outlier as that entertainment giant shifts back into profitability after COVID-19 mandates battered theme-park attendance in recent years.
But even excluding Tesla and Disney, the rest of these SPX-top-25 companies still averaged lofty 36.6x P/Es! That is still way up into the seriously-overvalued bubble zone where bear markets have a far-higher probability of spawning. The big US stocks exited Q4’21 trading 2.6x higher than the historical fair-value for the US stock markets. Thus the major correction-grade selloff so far in Q1’22 is justified and overdue.
US stock prices wouldn’t be so crazy-high had the Fed not just effectively more than doubled the US money supply with $4,746b of new dollars wished into existence over the past couple years. And with that epic radically-unprecedented QE4 campaign officially ending this week, and the Fed threatening to start QT in mid-2022 to begin reversing that crazy monetary excess, these lofty QE-levitated stock prices can’t persist.
Paying too much for big US companies’ underlying earnings streams is ultimately a losing strategy over the long-term. Imagine you were buying a good house in a good location that has a historical fair-value of $600k. If you can purchase it near that price, it is probably a great deal. But if market distortions have temporarily forced this same house’s price 2.6x higher to $1,560k, you will almost certainly lose money on it.
Overpaying for stocks relative to their earnings, no matter how awesome the underlying companies are, isn’t wise. Market history has proven in spades that stock prices perpetually flow then ebb, rising in powerful bull markets before rolling over into brutal falling bears. While stock prices often double in bulls, they are often cut in half in bears! These bears exist to force stock prices back in line with corporate profits.
And despite the mounting SPX correction so far in 2022, bubble valuations are likely to be forced even higher as corporate earnings erode. The raging inflation unleashed by this profligate Fed’s extreme money printing is the primary reason. This week’s latest official Consumer Price Index read on inflation, which is intentionally-lowballed by the government, still came in up a scorching-hot 7.9% YoY in February!
That’s the fastest general-price increase since January 1982, over four decades ago! The higher prices resulting from relatively-way-more money chasing relatively-less goods and services leave Americans with less disposable income to buy what big US companies are selling. People forced to spend more on essential necessities like food and energy can’t buy as much discretionary stuff on Amazon or at Home Depot.
Consumer spending increasingly constrained by the staggering double-digit price increases we are all suffering will drive down corporate sales and profits, lifting valuations farther. And the big US companies themselves are seeing major margin pressures as their input costs soar in the Fed’s monetary inflation. They pass along as much of these higher costs as they can in price hikes, but some still must be absorbed.
That forces earnings lower, driving valuations higher. The pricing power even the largest US companies have is limited, because most of the goods and services they produce are discretionary and there are plenty of substitutes. Spiraling-higher prices eventually retard demand, as consumers get tired of paying them and slow or stop their buying. We are all constantly making these decisions about our spending.
Less spending on any company’s goods or services for any reason directly forces earnings lower. Even the elite large US companies certainly aren’t immune from the economic law of higher prices almost always leading to lower demand. Serious inflation simultaneously degrades corporate profits on multiple fronts. With QE4 ending, Fed rate hikes starting next week, and prices soaring, Q4’21 could prove peak earnings.
The big US stocks’ dividends looked nowhere near as robust as sales and profits, merely edging up 2.5% YoY in Q4’21 near $31b. Corporate managers much prefer stock buybacks, since higher dividends do nothing to inflate their compensation. Operating-cash-flow generation excluding the giant money-center banks was even weaker last quarter, slumping 2.6% YoY around $193b. Fading OCFs are a bearish sign.
Operating cash flows are cleaner than GAAP earnings in many ways, with fewer estimates feeding into them. Again Berkshire reported colossal Q4 profits of $39.6b, thanks to those $40.5b investment gains. But the OCFs spun off by its large stable of businesses dropped 26.1% YoY. That indicates they weren’t faring anywhere near as well as the best-of-times record-high stock markets implied they should have been!
With big US stocks’ valuations so dangerously-high and corporate earnings coming under serious pressure from inflation, early 2022’s young correction-grade selloff isn’t finished. By late February that SPX loss since the FOMC minutes declared QT was coming extended to 11.9%. Yet exiting that month just a few trading days later, the entire SPX’s 500 stocks still averaged TTM P/Es of 29.4x festering in bubble levels.
With Fed-goosed stock prices so wildly-disconnected from corporate profitability, way more selling will be necessary to restore reasonable valuations. That likely means a bear market is getting underway, which will probably again at least cut the S&P 500 in half. Stock investors can prepare for this by greatly upping their meager portfolio allocations in gold. This counter-moving asset thrives in both stock bears and inflation.
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 very bearish for stock markets. Gold and its miners’ stocks, which really amplify their metal’s gains, are now surging in major breakouts. Those are attracting investors back, and their buying fuels massive bull uplegs.
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The bottom line is big US companies’ Q4’21 fundamentals are precarious. While they reported fantastic revenues and earnings growth, their stock prices remained excessively-high. They are still trading deep in dangerous bubble territory thanks to the Fed’s extreme money printing. That’s a serious problem with major Fed tightening imminent, first launching a new rate-hike cycle then starting to unwind QE through QT.
Ominously big US stocks’ valuations will likely be forced even higher as their earnings suffer withering pressure from raging inflation. Unleashed by the Fed effectively more than doubling the US money supply in just a couple years, higher prices will hammer profits. Companies won’t be able to pass along all their soaring input costs, as price hikes will eventually slow demand. All this is really bearish for the SPX’s outlook.
Adam Hamilton, CPA
March 11, 2022
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