The TSX and Dow Jones continued to be some of the best-performing indexes over the last month, as it seems that there has been the start of a rotation out of high-growth technology stocks and into what I like to call, “real economy” stocks.
I’ve been speaking on this routinely in the weekly newsletters for about a month. Although it is far from guaranteed that a rotation out of semiconductors and technology names will continue, there is no doubt that it is happening at this point, at least.
The Dow Jones and TSX are two of the best-performing indexes over the last month after falling short of the NASDAQ and S&P 500 for a long time.
I’ve been stubbornly patient with a lot of my Canadian holdings, to the point where some investors have stated it is to my detriment. However, my portfolio is up around 5% on the month, and if a rotation continues, I expect my portfolio to outperform most major indexes moving forward as well.
Many small-cap stocks are now seeing capital flow back into them, including numerous Bull List stocks and ones I am long, such as Aritzia (TSE:ATZ), Savaria (TSE:SIS), and Well Health (TSE:WELL).
In this week’s newsletter, I’m going to speak a bit on what exactly is causing the rotation, along with some highlighted stocks here that reported earnings.
I won’t speak on my portfolio moves this week, as I didn’t have any. The last major move I made was last week, initiating a 2.5% position in recent Bull List addition Toromont Industries (TSE:TIH).
Remember, all of our Bull List reports are readable from the website, and we encourage members to stay up to date on the companies we highlight as we update their reports every quarter.
The cause of the instability in the S&P 500 and NASDAQ this week
As I’ve stated for a while now, semiconductor stocks and, to an extent, many technology stocks are what I like to call “priced to perfection.”
What this means is that although valuations at this current time could certainly be justified if future growth expectations are hit or even exceeded, there can be significant volatility to the downside if a particular company reports weak earnings, or if there is some sort of notable news event that could shake the landscape of the sector in question.
When it comes to semiconductor companies, it was both of these. ASML Holdings, a popular semiconductor company, reported earnings on Wednesday that topped expectations on both a revenue and earnings front.
However, forward guidance issued by the company came in well below what analysts were expecting and as such, the company is down 17% over the last week.
It is not that ASML issued lower guidance. In fact, the guidance was exactly the same as what it issued at the start of the year. However, it seems like analysts were expecting some sort of upgrade.
The particularly interesting element about this is that although it is just one individual company reporting soft earnings, it will no doubt effect the entire sector, as many investors likely fear slowdowns will occur industry wide.
The thought process may be if ASML reported weak earnings, is there a chance NVIDIA, Broadcom, or Taiwan Semiconductor could report soft guidance and weak earnings as well?
When we invest in companies that, in my opinion, have valuations that will be hard to justify over the long term, we have to be able to accept the fact that there will be large-scale volatility in the event a company has subpar earnings.
Could ASML be alone in their soft guidance? Certainly they could. However, if we get softer guidance from any of the other major semiconductor companies, there will be significant volatility to the downside, that is almost a guarantee.
Outside of the risks of corporations themselves not hitting lofty expectations, we have one of the biggest notable risks among semiconductor companies that no one seems to be talking about, and that is regulatory risks.
Trump’s comments on Taiwan pose regulatory risk
Donald Trump issued a fairly aggressive statement last week regarding Taiwan, stating that the country should be paying the United States for defense against China, because Taiwan doesn’t “give the United States anything.”
Trump then went on to speak about Taiwan’s semiconductor industry, stating that it took “about 100% of America’s chip business.”
Although corporations like NVIDIA are located in the United States, they rely heavily on Taiwan, primarily Taiwan Semiconductor, to produce their chips.
In the event there are any issues between the United States and Taiwan that lead to regulatory changes, this could impact many US-based semiconductors in a big way.
In addition to this, the Biden administration has thrown around the idea of using extremely strict export protocols, which could limit foreign companies from distributing goods to China, as it attempts to stop China from being able to access high-grade chips and semiconductors.
Ultimately, both of these issues could severely impact these companies abilities to distribute chips to one of the largest markets in the world.
What exactly does this mean for the markets?
It is difficult to say how bad the situation could get, but comments made by both parties pose a bit of regulatory risk when it comes to these semiconductor companies. Combine that with some soft earnings from ASML, and we have a situation where we could be in the beginning stages of a large drawdown of semiconductor stocks.
Because of the record levels of concentration of the top holdings in the S&P 500, we could continue to see large volatility from the index and possibly even a correction in the index.
I’ve mentioned a few times that I feel a correction of the S&P 500 is a “when,” not “if” situation. It is just extremely hard to predict when it will happen.
As long-term investors, we shouldn’t necessarily be concerned with the short-term movements and corrections in the market. However, I have spoken a few times about how expensive I felt the S&P 500 index was.
The point of this newsletter isn’t to encourage investors to panic and sell off their S&P 500 ETFs. We’re long-term investors, remember?
However, it would have been easy for me (and for a lot of retail investors) to sell their weak-performing holdings to try and chase returns from the index and the surge in tech.
However, as I mentioned, I have held on to many of my laggard holdings with a long-term mentality, knowing that eventually, a rotation out of tech and into these names would occur.
It’s impossible to say whether or not the rotation will continue, but by the looks of it, there is no doubt it’s starting. It will just be interesting to see if momentum continues in this regard.
Earnings
Blackrock (BLK)
Blackrock posted a strong second quarter of Fiscal 2024. Revenue of $4.81B topped estimates by $30M, and earnings per share of $10.36 beat estimates of $9.96.
The company is posting a record start to the year when it comes to inflows to its ETFs. Total inflows through the first 6 months of the year sat at $139B, with $82B of them coming in this quarter. The company’s total assets under management now sit at $10.6T, which is up $1.2T year over year.
The inflows have resulted in a 3% bump to Blackrock’s fee-based revenue and a 12% boost to operating income.
When we look to year-over-year numbers in terms of revenue and earnings growth, they grew by 8% and 10%, respectively. Considering the sheer size of Blackrock as one of the largest asset managers on the planet, the fact it can still drive double digit earnings growth is impressive.
The bulk of the company’s ETF inflows are coming from North America. In terms of product types in regards to the company’s total assets under management, equities now sit at 55%, fixed income 26%, multi-asset 9%, and the remainder being currency and commodity based.
Overall, the company is benefitting from a surge in popularity when it comes to the equity markets despite a relatively rough economy and a tighter consumer. As interest rates decline and consumers have more spare money to invest in the markets, we could see the company’s retail segment pick up in popularity yet again, leaving Blackrock with plenty of runway despite its already large size.
UnitedHealth (UNH)
UnitedHealth reported a strong second quarter of Fiscal 2024, and has put practically all of the cybersecurity breach worries behind them. The stock has been on a torrent pace since, with its share price increasing by nearly 27%.
The company reported revenue of $98.8B, which was relatively in line with estimates and earnings per share of $6.80 topped expectations by 2.49%.
Even though the concerns of amplified losses due to the cybersecurity breach are behind them, there is still no doubt it is impacting results. The company stated it had a $0.92 impact to earnings per share as a result of the attacks. $0.64 of that was due to direct responses in terms of getting its platform back up and running and the result of increased costs of medical care due to the outage, and $0.28 was due to actual business disruptions.
Overall, the company states the attack will impact earnings per share by anywhere from $1.90-$2.05. This is a big hit to earnings, but it was projected to be much bigger, so this is a good sign.
The company’s Optum department, which provides direct care as well as data and analytical research, is fueling the bulk of the company’s growth at this point.
The company reported a medical care ratio of 85.1%. You’ve seen us talk about the combined ratio with multiple insurers, primarily our Bull List stock Intact Financial, which is the percent of money paid out in comparison to premiums collected. For example, a company paying out $85 for every $100 it collects in premiums would have a combined ratio of 85%. You can think of the medical care ratio as the same thing, but in regards to insurance claims paid out for medical care. This is a strong ratio and one of the best in the business.
Back in June, the company came out with a 12% increase to the dividend, its 15th consecutive year of growth.
Overall, it was a strong quarter from UnitedHealth, with double-digit revenue and earnings growth.
Aritzia (TSE:ATZ)
Aritzia continues to post strong quarterly results despite some harsh economic circumstances. Of note, the estimates inside of the table in the “recent earnings” section of our report have been adjusted upwards by double digits, as analysts are now becoming more bullish on the company as it continues to turn operations around.
Revenue was in line with expectations. The big surprise was earnings per share, which came in 35% above estimates. Overall, revenue grew by around 7.8% on the year and comparable sales, which isolates new stores from its results, grew by 2%.
At this point in time, nearly all of the company’s growth is coming from the United States, as revenue was up 13% year over year compared to under 2% from Canada. US revenue now makes up more than 57% of the company’s overall business, and if you’ve been a long-time follower of Aritzia, you’ll remember that even a few years ago, this number was below 45%
As we’ve mentioned numerous times in this report, one of the primary theses for Aritzia is its ability to expand and scale in a population that is 10x bigger than Canada’s, and currently it is executing.
Inventories are down to $396M, which is 22% lower than the peaks it hit in late 2022, which is what drove the vast majority of the fear and thus the drawdown in Aritzia’s stock price. Because of the stabilization of inventories, gross margins improved by 510 basis points (5.1%) and now sit at near all-time highs.
The company opened a total of 4 more boutiques when compared to the first quarter of last year. In terms of its guidance, it remained relatively cautious and maintained its previous targets despite a relatively strong rebound quarter, but I do have a feeling if they continue to post earnings like this, we will see the company revise guidance upwards.
Overall, it was a strong quarter from the company, and the turnaround story seems to be in full force.
