The market seems to be giving me a birthday present today with a strong pullback. It had been so long since we'd seen a selloff that I was wondering what those red figures were on my screen. Even as I put another year in the books and lament the increasing frequency of my own senior moments, though, I still remember how to analyze stocks. That skill may or may not fall into the category of lost arts, but numbers matter. I would say that today is an example of that, but it is really not, as the market is falling owing to weirdly amorphous "concerns about global growth," concerns that were amplified by National Economic Council chief Larry Kudlow's comments that a "sizable distance" remains between the U.S. and China on a trade deal.
But today's plummet in shares of Twitter (TWTR) is yet another example that numbers do matter, especially numbers delineating operating expenses. So, if you are bold enough to own individual stocks, you need to know the numbers. If you prefer ETFs and top-down strategies, thanks for reading this far and I hope you enjoy the work of the other great authors on Real Money's platform.
If you are still with me, please indulge me on my special day and sit through a short finance lesson. You may tire of reading about margins, margins and margins during earnings season, but remember any margin is a product of a mathematical calculation, not a product of any business model. Margins are an effect, not a cause, and they are driven by three things: units, price and cost. This is the old Fidelity method of analysis -- UPC, they call it -- and it has worked for decades, if not centuries.
In the tenth year of an economic expansion, investors should be focusing on corporate operating costs. There is just not that much unit volume growth in any industry in the West that I can think of, and China's closed markets -- hence Kudlow's sizable distance comment -- and India's move toward protectionism (which hit Amazon (AMZN) stock after management commented on it during its earnings conference call) mean that Western companies have limited access to the world's two largest markets.
So, if units are not growing, price probably will not, and Fed Chief Jerome Powell and his cronies on the FOMC seem to think there is no inflation anywhere in the U.S. economy. So that only leaves one of the UPC factors as a real driver of the pace of earnings growth: cost.
In this Chinese Year of the Pig, U.S. companies are going to have to cease their piggish ways to maintain earnings growth. The mega cap tech giants offer so many examples of rising embedded costs. Amazon's expansion into Queens, Apple's (AAPL) weird spaceship headquarters in Cupertino, Salesforce's (CRM) skyscraper in San Francisco, Alphabet's (GOOGL) purchase of seemingly all the commercial real estate in the Chelsea neighborhood of Manhattan, etc. All of those edifices cost much money and none of them directly generate a single dollar of consumer revenue.
Investor fears of margin compression drove the U.S. stock market's decline in 2018 and believe those fears will re-emerge to produce a correction in 2019 that will reverse January's strong gains. I have referenced John Butters of FactSet's excellent Earnings Insight product many times in my RM column, and I will do it again today.
Consensus estimates for the S&P 500 call for revenue growth of 5.7% year-on-year in the first quarter, but an earnings decline of 0.8%. That's margin compression, plain and simple, and that is caused by rising costs for infrastructure, labor and overhead, not materials. Companies that are less exposed to the potential benefits of an extended downturn in prices of main commodities, such as oil, are really left with the Hobbes' choice of raising prices and ceding market share or accepting lower margins. It is clear what managements at the S&P 500 are doing in aggregate, and that is why I don't own any S&P 500 stocks for my clients.
Another year older hopefully means wiser, as well, and I won't lose money for my clients by buying stocks in companies that are facing lower margins. I am sticking with corporate bonds.