Weekly Investment Update (07/30/2021)
Big Tech Earnings Beat, But Investors See Slower Growth Ahead
The five largest U.S. technology companies, or “Big Tech,” reported earnings this week. While results generally exceeded Wall Street’s high expectations, investor optimism was slightly tempered by signs that the elevated growth over the past year may be slowing, in line with recent trends within the broader technology industry. Amazon’s earnings miss highlights this tempered optimism, as the stock fell ~7% Friday morning after showing a steeper deceleration in retail growth than had been expected.
The trend of accelerated digitization during the pandemic saw technology stocks soar to new highs as consumers confined to their homes needed more technology-oriented products and services. Despite the lockdowns being lifted and people traveling again (see our July 16 Weekly Investment Update), company earnings remained robust as retail consumers and businesses alike continued to spend on these platforms, pushing earnings to record highs.
While results were mostly better than expected, investors were moderately concerned that it will be difficult for these companies to maintain this level of growth going forward. As Google Chief Financial Officer Ruth Porat stated, “In the second quarter, we continue to benefit from elevated consumer online activity," but toned down forward guidance saying, “We believe it is still too early to forecast the longer-term trends as markets reopen, especially given the recent increase in COVID cases globally.” Similar cautious tones were provided by Apple and Facebook; however, fundamentals remain strong, and these companies maintain a long-term focus on delivering competitive returns to investors.
The five Big Tech names have dramatically outperformed the other 495 names in the S&P 500 index since the pandemic began last January. The five technology companies gained ~90% on average since January 2020, compared to ~35% on average for the rest of the names in the S&P 500. Bessemer’s equity portfolios are invested in stocks that reported earnings this week (e.g., Amazon, Apple, Google, Microsoft, and Facebook). We believe these companies exhibit impressive competitive moats as well as strong long-term growth drivers. These businesses have leading positions in fast-growing markets and significant competitive advantages, and we believe they are among the best companies for long-term capital appreciation.
Variants in Focus but Unlikely to Derail U.S. Economic Recovery; Booster Vaccines Being Trialed
COVID-19 vaccines were all developed based on the genetic makeup of the COVID-19 virus originally identified in Wuhan, China, in 2019. Since then, more dominant strains have emerged, and vaccines have been less effective at preventing symptomatic and asymptomatic cases of the Beta, Gamma, and Delta variants. The risk has also emerged that immunity may wane faster than was originally anticipated. Existing scientific evidence suggests that the currently available vaccines are all highly effective at preventing severe cases regardless of the variant.
The increasing prevalence of more transmissible variants has compelled leading vaccine developers such as Pfizer and Moderna to begin developing and testing booster vaccines. Initial results from Moderna’s vaccine booster trial are very promising: the booster shots materially increase neutralizing antibody levels that target the original virus as well as the Beta and Gamma variants. Scientists are also testing the possibility of using an mRNA vaccine as a booster for individuals who received a JNJ vaccine.
The potential need for boosters is something that we are monitoring closely. This should become more relevant in the fall, when those who received vaccines initially will be around eight to nine months post full vaccination and the annual flu season will be set to begin. We note that Israel has already begun administering booster shots to immunocompromised individuals this week, and adults 60 and over who received their second dose at least five months ago will be eligible starting on Sunday.
We do not believe the U.S. economic recovery will be derailed by recent COVID-19 developments. Amid the latest increase in cases, the high-frequency indicators have continued to suggest high activity levels. Additionally, most individuals most at risk for severe disease are fully vaccinated, helping prevent the healthcare system from becoming overly taxed and preventing many deaths as the Delta variant spreads across the country. There are nuances in various areas of the U.S., which we discuss in the following section.
Other developed economies are in similar positions to the U.S. Should we see a material rise in cases, we do not expect an outcome resulting in widespread lockdowns and the halting of economic activity. However, some containment measures, such as mask mandates, may be temporarily imposed on a local level. Challenges for emerging market economies are likely to be greater given that many people remain unvaccinated or have used vaccines with lower efficacy rates than those used in developed markets. Additionally, the potential need for booster vaccines will likely exacerbate supply constraints faced by many emerging market countries, especially since developed-market economies may now use the excess vaccines ordered as booster shots rather than donating them to other countries.
Consumer Confidence Varies Across States While Pent-up Demand Continues to Surface in Survey Data
At the national level, consumer confidence remained high in July with jobs perceived as very abundant and 12-month inflation expectations holding at elevated levels (6.6%). Additionally, despite recent gains in automobile and home prices, which are interest-rate-sensitive sectors, there is evidence of growing pent-up demand for the purchase of large-ticket items, such as major appliances, seen in the Conference Board’s sub-indexes. We continue to expect these avenues of consumer demand to remain robust throughout the second half of the year as the saving rate of 10.9% remains high relative to the pre-COVID-19 rate of 7.4%.
When looking beneath the surface, however, sharp declines in confidence can be seen in states and regions experiencing low vaccination rates and faster COVID-19 case growth. With Texas, Florida, and Missouri accounting for roughly 40% of the most recent increase in new cases, confidence levels there were impacted most materially. Specifically, confidence in Texas fell 13.9 points in July, fell 7.4 points in Florida, and dropped 10.8 points in West South Central (AR, LA, OK, TX). By contrast, confidence in New York rose 7.3 points in July.
Overall, trends in growth remain strong, consumer demand remains robust, and business inventories remain very low relative to history. In an environment of disrupted supply chains, we are likely to see businesses rebuild inventories amid higher input costs, which may lead to higher price levels for longer than the Fed is suggesting. For this reason, among others, we continue to focus on owning businesses with scale, pricing power, and high-quality balance sheets.
Higher Prices Ate Into Second-Quarter Real GDP
Real GDP rose 6.5% at an annual rate in the second quarter. While the increase came in below market expectations, the 6.1% gain in the GDP price deflator, a drop in inventories, and increased imports ate into the real GDP number. On a nominal basis, GDP registered 13.0%, showing that higher inflation affected spending.
Notably, real GDP is now higher (by 0.8%) than the fourth quarter of 2019 and is only 1.7% short of the CBO’s estimate of potential GDP. With the inventory-to-sales ratio dropping to 3.8 from a pre-COVID-19 ratio of 4.2, when supply chains ease, growth should be supported by restocking.
— Bessemer Investment Team
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