๐๐ Megacap Valuations Blowing Up Again
Happy Sunday!
We are getting back into the swing of things, and Iโm excited to start working and making content after some time off!
This week, we discuss how inflated valuations have gotten for some of the largest companies in the world and why Tesla has dipped as of late.
Hope you enjoy this weekโs Sunday Primer!
- Humphrey, Tim & Rickie
Market Report
This week, ~170 companies in the S&P 500, collectively accounting for 40% of its market cap, will report quarterly earnings. This includes Microsoft, Meta, and Alphabet. In addition, Jerome Powell and the Fed will announce its interest rate decision. Growth stocks are generally highly sensitive to interest rates, which are used to calculate what earnings in the future are worth right now. Tech has rallied this year as its profits have proven to be resilient and as the Fed slows down the pace of its rate hike.
The five biggest companies in the index (Apple, Microsoft Amazon, Nvidia, and Alphabet) trade at a combined 30 times forward earnings, the highest since March 2022. Thatโs nearly twice the multiple for the rest of the index. As the market continues to run up, concerns about a growing bubble continueโฆ
The bear market that decimated the S&P 500 less than 20 months ago is close to being entirely wiped out, with the index now close to a complete recovery. Despite some US economic signals not being as positive and the Federal Reserve maintaining its cautionary stance on inflation, investors are buying, marking the eighth week of increases in 10 weeks. If this optimistic trend continues, the bear market of the past year could see one of the fastest recoveries since World War II.
Close to $10 trillion in value has been regained over the past nine months and the S&P 500 has seen a 27% rise from its low point in October and is now just 5% away from achieving its all-time high from January 2022.
However, just because the markets are doing well doesnโt necessarily mean that all is well. U.S. consumers, especially those in the lower-income bracket, are beginning to face financial hardships as the savings accumulated during the pandemic deplete.
The reduced liquidity among households, particularly in the bottom 40% income bracket, is expected to impact consumer spending growth and signal an economic slowdown. Access to credit is also becoming more challenging, with banks tightening lending standards and increasing rejection rates for credit cards, mortgages, and mortgage refinances, especially for borrowers with poor credit histories. Distress signs are already visible in the auto market, where delinquency rates for prime and subprime auto loans have reached record levels for May in over a decade.
Tesla Stock Tumbleโฆ
Tesla shares fell this week after the company warned of further weakening to its already diminishing profitability, mainly due to persistent price reductions on its electric vehicles. Elon Musk has stated that Tesla will need to continue reducing prices if interest rates keep rising, a strategy that has already negatively impacted Teslaโs automotive gross margin, bringing it to a four-year low in the second quarter.
Tesla is also investing heavily in new models, such as the delayed Cybertruck, and the Dojo supercomputer, for which Musk plans to spend at least $1 billion by the end of next year.
Despite these challenges, Tesla is still on track to produce approximately 1.8 million vehicles in 2023, although production will decrease this quarter due to factory upgrades. Barclays noted that Tesla's gross margin recovery could be slower than anticipated as the company relies on discounting to drive volume. They also predicted earnings pressure due to higher operational expenditures as Tesla invests in AI and other growth projects.
In addition to these concerns, Tesla's growing inventory of cars adds to the company's challenges. Despite deep discounts on best-selling models and incentives like free charging, Tesla's global supply of vehicles increased to 16 days, up from just four days a year ago. While new models like the Cybertruck could help Tesla maintain its sales growth rate, the vehicle won't be available in large volumes until next year.
Although Tesla's profits and revenues exceeded expectations, the results have damaged many investorsโ confidence that margins have reached their lowest point. The company's CFO, Zachary Kirkhorn, had previously forecast a more than 20% automotive gross margin, but this prediction was revised after the company dropped to 18.1%, the lowest since Q2 2019. Despite these challenges, Elon Musk maintains that the slimmer profit margins are short-term issues and believes that Tesla's potential to offer autonomous-driving capability will increase the companyโs valuation.
Forecast Ahead
Big Number: 83.5%
Americans between 25 and 54 years old, defined as prime working age, are now participating in the labor market at rates unseen in two decades, counteracting the impact of older baby boomers leaving the workforce. During the early stages of the pandemic, nearly four million workers in this age range left the job market, reducing participation to its lowest level since 1983. However, participation of prime-age workers has not only rebounded but also exceeded pre-pandemic levels by approximately 2.2 million.
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