November Market Update
Bringing you our monthly market update! November has been yet another month full of highs as the Twitter IPO was oversubscribed 30 times, priced at $26/share, opened at $45.10 then jumped up to $50.09 to then close below its opening price at $44.90 in its first day of trading. If you had any doubts that there may be the tiniest bit of a stock bubble, a company that has never turned a profit, generated $320m in sales in 2012 and is expected to generate $637m this year, while still losing money, was valued at $18.1 billion in its first day of trading.
If that doesn’t convince you that equities, and particularly internet equities are getting awfully hot. The 23-year-old CEO of Snapchat, a two year old company with no revenue, last week rejected a $3 billion, all cash, buyout offer from Facebook. One can’t help but think back to the heady days of 1999.
The S&P 500 continues to mount up new 52-week highs, while revenue growth has been lackluster and earnings growth rates continue to decline as companies are running out of areas to cut costs. From an aggregate fundamental perspective here is where we stand:
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Companies are running out of places to cut costs, after having spent years trimming after the onset of the financial crisis.
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Profit margins are at all-time highs, with limited opportunities for continued cost cutting.
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Labor costs are on the rise, which will cut into profit margins.
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Interest rates are more likely to rise than fall in the coming years, which will also cut into profit margins.
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This year’s stock market gains have been driven primarily by expansion of the P/E ratio, recall our discussion of this topic in our August and September 2013 issues.
Bottom Line: With the current elevated P/E levels and record profit margins, stock price appreciation will have to come from even higher P/E ratios or earnings growth, making further double digit gains from this point less likely without continued stimulus from the Federal Reserve, which of course comes with risk. We would like to see a pick-up in earnings in order to justify domestic equity prices as these current levels.
