Apple and the R Word
Why stocks rallied last week, and where they are headed through the end of the year.
The Federal Reserve Board keeps raising rates at a rapid pace. The economy experienced two quarters of contraction. So, why haven’t stocks absolutely tanked?
Interest rates are finally starting to reward savers. So, when will investors yield to the temptation of fixed income over equities? Are we in a recession? Will it be mild or severe? Just as importantly, should we fix the roof of our financial house now, while the sun is still shining?
The answers to those questions lie in the world’s most popular fruit that is almost always in season – Apple – and its $88 billion in buybacks, and the R word that cannot be named (recession).
Below are 5 Important Considerations and 1 Bottom Line
The R Word hasn’t Been Uttered Yet
If You Wait for the Headlines, It’s Too Late
Small Caps Have Been Killed
And here is a little more color on each point.
Apple is scheduled to report their fourth-quarter earnings on Thursday after the market closes. As happened in the most recent quarter that ended June 25, 2022, earnings are expected to be slightly above where they were last year in the same quarter. The strong dollar is providing some headwinds that could impact revenue (up to $5 billion). But the strength of the business itself is expected to keep earnings on par. Apple remains the #2 smart phone company by units (and #1 by revenue).
Apple has become pervasive in our lives, from the device we can’t live without in our hand, to something we stream and dream about as well. As you can see in the charts below, Apple’s revenue comes in from all over the world. The company is doing a great job of diversifying its income stream. The services and iPhone revenues were higher year over year, while Mac and Wearables revenues were down -10% and -8% respectively, and iPad sales were down -2%.
With a market value of almost $2.4 trillion, annual revenue of $367 billion, $95 billion of which is profit, and $180 billion in cash and marketable securities, Apple is a dominant force on Wall Street. Apple’s buyback plan is so aggressive that the markets tend to go in tandem with Apple’s share repurchases. When Apple pauses, the market drops (as it did severely in December of 2018) – the worst December since the Great Depression, with losses of -9.1%.
In 2021, the company spent over $88 billion buying back its own stock. 2022 is trending higher with $24.6 billion spent in the second quarter of 2022, and $47.5 billion spent in the first six months.
The S&P500 is down -22% since the highs of Jan. 2022. Without Apple support, the drop would likely have been far worse. The question going forward is, “Will the company continue to buy back as robustly in the 2nd half of 2022?” All eyes and ears are definitely going to be on the forward guidance presented at the earnings call on Thursday. Apple isn’t giving hard numbers, however they are providing enough color to gauge whether or not they’re anticipating a strong holiday buying season.
Why did Apple stopped repurchasing their own stock in December of 2018? Huawei had taken a big bite out of Apple’s dominance. In the third quarter of 2018, Samsung and Huawei were the top global smart phones sales providers (by units), while Apple was in third. After that, Apple was successful in wiping out Huawei. However, will budget belt-tightening impact Apple sales now and going forward? With the entire market at stake, this is a consumer pulse to keep a finger on.
The R Word hasn’t Been Uttered Yet
Another reason that stocks rallied last week is that the National Bureau of Economic Research, nber.org, the NGO responsible for naming the sessions, hasn’t made an official declaration of a recession. The agency is notoriously slow about that. As examples, the organization announced the great recession on December 1 of 2008. That was just a few months away from the March 9, 2009 bottom. In fact by the time the recession was called, stocks had already declined -42%. The Dot Com Recession was called on November 26, 2001, after the NASDAQ Composite Index had already posted losses of -66%.
The NBER was relatively fast to call the pandemic recession on June 8, 2020. However, the S&P 500 had already plunged almost -40% and was actually on its road to recovery by the time the announcement came.
If You Wait for the Headlines, It’s Too Late
As you can see in the examples cited above, if you wait for the recession to be officially called, it’s too late to protect your wealth. In fact, it might be closer to the bottom. Many people are tempted to sell low at the time the recession is announced. There were a lot of people who missed out on most of the secular bull market of the last decade because they freaked out at the bottom of the Great Recession, and weren’t ready to get back in until the late stage of the business cycle.
Small Caps Have Been Killed
There has been a real mismatch between large caps and small caps over the last few years. This has a lot to do with those buy backs that we discussed at the beginning of the blog. Because small companies don’t buy back their own stock and have to borrow money to build the infrastructure and factories they need to expand, even good companies have been destroyed this year. Whereas the general market is down -22%, share prices for many small cap stocks and funds are down -35% of more. This is an area that offers more value.
Check out Warren Buffett‘s favorite valuation tool in the chart below. As you can see, stock prices are still very overvalued historically. During periods of heightened values, equities tend to drop farther and faster.
The Federal Reserve Board is trying to alleviate panic and prevent a repeat of the Dot Com and Great Recession drops (of more than half) by characterizing the expected coming recession as “mild.” A strong labor market is a positive, while zombie companies, inflation and weak, overleveraged industries are all very negative. As we have pointed out quite a lot over the past few years, over half of the S&P 500 is at or near junk-bond status. Debt and loans (leverage) has soared to levels never seen before.
Extended periods of low interest rates create asset bubbles. Rising interest rates are going to make it more difficult for troubled companies to keep borrowing from Peter to pay Paul. Industries that are more vulnerable include commercial real estate, retail, highly leverage financial services (like insurance companies, which typically do very poorly in recessions), travel, airlines, advertising-supported businesses (like social media) and other industries that are reliant on consumer discretionary spending.
Most of us will continue to need our smart phones, our Wi-Fi, food, housing and other basic needs. We may, however, try to make our existing devices last longer, rather than getting the bright new shiny object. For this reason, it’s never a good idea to just sell all of our stocks.
On the other hand, we are overweighting an additional 20% safe in our sample pie charts. Click to access our free web apps where you can personalize your own pie chart.
Email info@NataliePace.com if you’d like to see our MAAAM Stock Report Card (Microsoft, Apple, Amazon, Alphabet (Google) and Meta (Facebook).
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Natalie Pace is the co-creator of the Earth Gratitude Project and the author of The Power of 8 Billion: It's Up to Us, The ABCs of Money, The ABCs of Money for College, The Gratitude Game and Put Your Money Where Your Heart Is. She is a repeat guest & speaker on national news shows and stages. She has been ranked the No. 1 stock picker, above over 830 A-list pundits, by an independent tracking agency, and has been saving homes and nest eggs since 1999.