The big US stocks dominating investors’ portfolios have reached a key technical juncture. They’ll soon either bounce off major support to extend their bear-market rally or continue breaking down towards bear lows. Their just-finished Q4’22 earnings season offers great fundamental insights on which path is more likely. Ominously exiting last quarter valuations remained high, right on the edge of formal bubble territory.
The mighty US benchmark S&P 500 stock index (SPX) contains many of the biggest-and-best stocks on the planet. Leaving 2022, these giant companies collectively commanded an enormous $34,246b market capitalization! Nearly every investor has substantial-to-huge portfolio exposure to the biggest companies in the SPX. Their stocks’ fortunes also overwhelmingly drive the price action in the entire US stock markets.
The SPX enjoyed a strong Q4, powering 7.1% higher. But that was much less impressive considering the broader context. In early January 2022, the S&P 500 achieved an all-time-record closing high of 4,797. Then it started nosing over into a major selloff on the Fed’s most-extreme tightening cycle ever. In mid-June days before the Fed’s first monster 75-basis-point rate hike in 27.6 years, the SPX plunged into a bear.
An ugly 3.9% down day in anticipation of that uber-hawkish FOMC hammered the US stock markets into formal bear territory down 20%+. At worst in mid-October, that grew to 25.4% SPX losses in just 9.3 months! Most of the sharpest surges ever seen in stock markets erupt out of bear interim lows, the powerful bear-market rallies. One indeed ignited then with the SPX oversold and bearish sentiment excessive.
That’s the only reason the US stock markets surged during Q4’22. That blistering rally initially peaked in late November, with the SPX rocketing up 14.1% in just 1.6 months! Then that unsustainable advance stalled out, drifting lower to sideways into early February. The SPX finally achieved a couple more interim highs after the Fed chair waxed dovish following the latest FOMC decision, extending that bear rally to +16.9%.
But in the month since, the US stock markets have rolled over hard. Big selloffs hit on an epic seasonal-adjustment-fueled upside surprise in monthly US jobs, and hotter-than-expected CPI, PPI, and PCE inflation reports hawkish for the Fed. By mid-week, the SPX plunged 5.5% since early February! Over 3/8ths of that bear rally’s gains have been erased, leaving the S&P 500 hovering at a major-support-zone confluence.
That includes this strong bear rally’s uptrend support, and more importantly the SPX’s critical 200-day moving average. Decisive breakdowns from here would really crush bullish psychology, fueling selling that could easily cascade. That could soon slam the SPX down to new bear lows, which are just 9.5% under current levels at mid-October’s 3,577 closing low. It’s truly do-or-die time for this latest bear rally!
Big US stocks’ Q4’22 fundamentals will likely play a role in what happens next, tilting the scales towards a bearish outcome. For 22 quarters in a row now, I’ve analyzed how the 25-largest US companies that dominate the SPX fared in their latest earnings season. These behemoths alone commanded a massive 39.7% of the SPX’s total market cap exiting Q4! Their latest-reported key results 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 Q4’21. These symbols are followed by their stocks’ Q4’22 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 previous 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, maximizing 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 Q4’22 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 enough to stave off this young bear before it grows into a ravenous juggernaut.
Naturally stock markets behave very differently in bulls and bears. High-flying technology stocks often prove investments of choice in the former good times, while safer high-cashflow-generating sectors gain popularity in the latter bad times. So rather extraordinarily, during this past bear year nearly a quarter of these SPX-top-25 stocks changed! Six smaller market-darlings were knocked out of these elite ranks.
In the comparable Q4’21, Walt Disney, Broadcom, Adobe, Netflix, Cisco Systems, and Nike ranged from the 19th-to-25th-biggest US stocks. Back then they reported total quarterly revenues running $65.4b and earnings of $9.7b. Over this past year, those high-fliers were replaced by Exxon Mobil, Chevron, AbbVie, Merck, Coca-Cola, and PepsiCo. These new SPX-top-25 stocks are far bigger, particularly the oil supermajors.
All six’s sales and profits in Q4’21 ran $196.2b and $25.5b, fully 3.0x and 2.6x larger than those from the stocks they displaced! So comparisons between Q4’22 and Q4’21 are heavily distorted by this huge SPX-top-25 composition change. Skewing even worse, those mighty oil supermajors were last quarter’s best fundamental performers. XOM’s and CVX’s huge 73.6% and 52.3% market-cap gains crushed the competition!
Overall the SPX top 25’s total market capitalization collapsed a sharp 26.9% year-over-year to $13.6t, the worst levels since Q3’20. The oil supermajors’ strong contrary gains were certainly justified by their great fundamentals. XOM’s revenues and earnings soared 12.3% and 43.7% YoY, despite quarterly-average crude-oil prices only climbing 7.2% YoY near $83. CVX’s rocketed up a similar 17.3% and 25.7% in that span.
In addition to seeing the best combined sales and profits growth, these energy giants also remained some of the best fundamental values among the biggest US stocks. Despite their huge stock-price gains, XOM and CVX still left 2022 trading at super-cheap 8.9x and 10.1x trailing-twelve-month price-to-earnings ratios! Had they not ascended into the SPX top 25, its overall P/E would’ve stayed in bubble territory at 29.2x.
There’s one other heavily-distorting company in these elite ranks, legendary investor Warren Buffett’s gigantic Berkshire Hathaway conglomerate. It is the 5th-largest US company after the usual four market-darling mega-cap tech stocks. BRK’s earnings plunged from an epic $39.6b in Q4’21 to a way-smaller $18.2b in Q4’22. US accounting rules require companies to run unrealized stock gains and losses through income.
With the SPX again rallying 7.1% last quarter, BRK enjoyed big $14.5b unrealized gains. But those were dwarfed by massive $82.4b unrealized losses in 2022’s preceding quarters as this young SPX bear awakened. A year earlier in Q4’21, BRK flushed colossal $40.5b unrealized investment gains through its income statement as the SPX soared 10.6% that quarter to new record highs! BRK’s profits follow stock markets.
With those distorting caveats in mind, the SPX top 25’s overall sales continued looking impressive in Q4’22. They soared 20.1% YoY to $1,186.4b. Interestingly that was the highest witnessed during the 22 quarters I’ve been advancing this research thread, and probably ever. But that’s mostly driven by bigger companies like those oil supermajors and pharmaceutical giants forcing out smaller market-darling tech stocks.
Speaking of techs, the big four mega-caps dominating the US stock markets accounted for a third of SPX-top-25 revenues last quarter. Apple, Microsoft, Alphabet, and Amazon commanded a staggering 17.1% of the entire S&P 500’s market capitalization! If these market-leading generals sneeze, the entire US stock markets will catch a cold. Ominously their key Q4 fundamental metrics were worse than their peers’.
The big-four mega-cap techs’ total sales only edged up 1.7% YoY last quarter, barely growing. Yet the next 21 largest US stocks enjoyed awesome 32.0% total revenues growth. Even though that was mostly due to those six new component stocks, the exceedingly-important tech market-darlings’ sales growth has nearly stalled out. Apple actually suffered 5.5% YoY shrinkage, a potential hefty canary in the coal mine.
Despite that big SPX-top-25 revenues growth last quarter, bottom-line earnings plunged. Together they reported total profits of $169.0b, which dropped 16.4% YoY! The mega-cap techs proved far worse, seeing earnings collapsing 31.7% to $60.3b! Despite the new bigger companies, the next 21 largest US stocks still saw their total earnings retreat 4.4% YoY to $108.7b. Berkshire’s volatility certainly skewed this.
That huge conglomerate reported an epic $39.6b profit in Q4’21, which collapsed to just $18.2b in Q4’22. Again that plummeting was driven by stock-market fortunes forcing unrealized gains and losses through income. But even excluding BRK from both quarters, the other 24 biggest US stocks still saw their profits slump 7.1% YoY. And that includes those oil supermajors and large pharmaceutical companies newly added!
So the biggest US stocks’ most-important fundamentals are really deteriorating, which is really bearish for their stock prices. Those ultimately trade at reasonable multiples of their companies’ underlying earnings per share. Over the last century-and-a-half or so, fair value in the US stock markets has oscillated around 14x earnings. Twice that at 28x is where formal bubble territory begins, which eventually spawns bears.
Exiting Q4’22, these elite US stocks averaged lofty and dangerous 27.7x TTM P/Es. That was just shy of bubble levels, despite the undervalued oil supermajors entering the elite SPX-top-25 ranks! The big four mega-cap techs averaged 35.0x, while the next 21 largest US stocks looked modestly better averaging 26.3x. These festering high valuations despite this young bear’s mauling argue it has a lot of work left to do.
Bear markets exist for one reason, to force stock prices sideways to lower for long enough for profits to catch up. Valuations grow excessive with greed late in secular bulls, so bears awaken and rampage long enough to force valuations back down to fair value. That essential mean-reversion process usually sees a sizable overshoot to undervalued levels before bears give up their ghosts, sometimes as low as 7x!
So with these elite US stocks still trading near formal bubble valuations even after a bear year, odds are great they are still heading much lower. Even more valuation pressure will come from this raging inflation unleashed by the Fed’s epic money printing. In just 25.5 months into mid-April 2022, it ballooned its balance sheet an absurd $115.6% or $4,807b! That more than doubled the dollar supply in a couple years!
While the FOMC slammed though a shocking 450bp of rate hikes in just 10.6 months, high inflation will persist until the majority of that new money is destroyed. While the Fed has started selling bonds which shrinks the dollar supply, so far less than 1/8th of that epic monetary-expansion orgy has been reversed. So price levels will continue to normalize to a money supply still 101.6% above pre-pandemic-stock-panic levels!
Relatively-more money chasing relatively-less goods and services inexorably bids up their prices. High inflation is terrible for corporate earnings, squeezing them from both ends. Companies are forced to pay much-higher input costs for their raw goods, but can’t pass all of these to their customers through higher prices. If companies raise prices too much, customers balk. They slow or stop their buying, looking for substitutes.
So corporate price hikes erode market share, which soon leads to shrinking sales. That crushes earnings even faster, as they naturally leverage revenue trends. So even the big US stocks are facing both lower profit margins as their input costs soar and lower sales as their customers can’t afford to buy as much of their products. That portends lower overall SPX-top-25 earnings going forward, forcing valuations higher!
Interestingly there are already other signs these elite US companies are facing more financial pressure. They have long loved manipulative stock buybacks, which are a high priority for cashflows. In Q4’22, the SPX top 25’s total stock buybacks plunged 31.9% YoY to just $73.1b! That proved the lowest since Q1’21. Corporate executives wouldn’t give up their huge bonuses tied to higher stock prices without good reason.
Those big-four mega-cap techs fought the hardest to keep buying back their stocks, with their buybacks only slipping 2.5% YoY to $40.3b. The next-21-largest US companies’ buybacks cratered 50.3% YoY to just $32.8b! The only reason these giant companies would radically slow their buybacks is worries about their fundamental outlooks. Lower earnings ahead will leave less cash to plow into stock-price manipulation.
Even these lower stock-buyback levels look unsustainable. While not on this table, the SPX top 25’s total cash balances fell 12.6% YoY to $798.3b in Q4. Just like ordinary Americans facing financial stress, one of its signs at the corporate level is burning cash. As companies’ incoming cashflow wanes, their spending starts depleting their treasuries. That process is now underway even at the biggest-and-best US stocks.
That isn’t apparent in the SPX top 25’s operating cashflows last quarter, due to those huge composition changes. Overall these elite companies’ OCFs surged 12.8% YoY to $217.5b. Those mega-cap techs’ fell 9.7% to $98.0b, while the next 21 largest US companies’ soared 41.8% to $119.5b. But those six new SPX-top-25 companies generate far-larger operating cashflows than the smaller companies they displaced.
A year ago in Q4’21, the replaced stocks reported $10.1b in OCFs while the new stocks from this past year dwarfed that with $45.1b! Again Exxon Mobil and Chevron are the main reason, as oil supermajors generate massive operating cashflows. Overall the biggest US companies’ deteriorating fundamentals are impairing their operating cashflows. There’s another way to look at this without all these distortions.
We can exclude the six new and six replaced companies from their respective Q4s, as well as the two US mega-banks JPMorgan Chase and Bank of America. Their cashflows are exceedingly volatile quarter-to-quarter, swinging from crazy-negative numbers to hugely-positive ones. So for years I’ve excluded them from this quarterly OCF analysis. For Q4’22 and Q4’21, that leaves 17 common SPX-top-25 companies.
Their operating cashflows reported last quarter fell 8.0% YoY to $168.0b. Less cash coming in reflects poorer business fundamentals, which will lead to lower profits and higher valuations. That leaves more red meat for this ravenous bear to devour in coming months and maybe years. Lower OCFs also fuel increasing cash burn rates, leaving less money available to continue recent years’ huge stock buybacks.
The very last thing corporate managers will cut is dividends, as that angers income-seeking investors who flee leading to serious stock selloffs. Indeed the SPX top 25’s total dividends soared 44.3% YoY to $45.2b. But that was mostly driven by those six replacements, as Q4’21’s old ones paid just $3.7b then compared to $13.6b for the new ones then. Excluding them, the other 19 big US stocks’ dividends grew 5.5% YoY.
But eventually deteriorating fundamentals manifesting in lower revenues and earnings even filter down to dividends. We just saw a high-profile example of that. As recently as Q1’21, giant chipmaker Intel was an SPX-top-25 stock. In late January 2023 after reporting dismal plummeting sales and profits, INTC slashed its dividends going forward by a shocking 65.8%! That left Intel even deeper out of favor with investors.
So this latest Q4’22 earnings season didn’t look pretty. While the biggest US companies still managed to grow their revenues, their profits fell sharply. This is going to force their valuations even higher, even though they were already just shy of dangerous bubble territory exiting last quarter. Raging inflation will really cut into both earnings and sales going forward, leaving these elite US stocks even more overvalued.
Thus this young bear looks to still have lots of mauling left to accomplish its mission of mean reverting stock prices back to and likely under fair value. At these elite companies’ earnings levels and valuations leaving Q4’22 with the SPX at 3,840, this bear would still have to nearly cut stock prices in half merely to force valuations to 14x! A normal overshoot would mean even-bigger ultimate bear-market losses, which is scary.
Given this bearish backdrop, investors should be wary of their heavy capital allocations to these biggest US stocks dominating the markets. They should consider diversifying into gold. Exiting Q4 when all 500 SPX companies commanded that mighty $34,246.4b market cap, the gold-bullion holdings of the leading American GLD and IAU gold ETFs were only worth $79.8b. That implies gold allocations around just 0.2%!
That’s essentially zero, radically below the 5% minimum prudent investors have run for many centuries. Even better, gold soared during the only two other inflation super-spikes of this modern monetary era during the 1970s. In monthly-average-price terms from trough-to-peak CPI-inflation months, gold nearly tripled during the first before more than quadrupling in the second! Gold ought to at least double during today’s.
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The bottom line is the big US stocks’ latest quarterly results revealed ominous deteriorating fundamentals. While revenues climbed thanks to big composition changes with a young bear market growing, earnings plunged dramatically. This raging inflation super-spike unleashed by extreme Fed money printing is really squeezing profits. And companies can’t pass along all their higher input costs without really eroding sales.
Lower earnings are forcing near-bubble valuations even higher, despite already seriously-lower stock prices from when this bear awoke. This ravenous beast has a lot of mauling left to do before valuations are forced back down to or under fair value. So investors should consider lightening their huge portfolio allocations in the biggest US stocks. Some of that capital should be shifted into the ultimate inflation hedge, gold.
Adam Hamilton, CPA
March 3, 2023
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