Vitezslav Vylicil
The Nasdaq composite index was down over 30% from January to June but has since recovered about half of that decline. So, might it be time to dip the toes into tech waters again? Vitali Mossounov, Global Technology Analyst and Portfolio Manager, TD Asset Management weighs in.
Transcript
Greg Bonnell: This quarter’s earnings for big tech are out. And here to give us the highlights and lowlights is Vitali Mossounov. He’s the global technology analyst and portfolio manager at TD Asset Management. Vitali, great to have you on the show, looking forward to the conversation. Let’s start with a recap of what we saw in the quarter.
Vitali Mossounov: Yeah. Well, what we saw is — maybe, Greg, before we talk about what we saw, what did we see in Q4 and Q1? We saw two quarters that had investors on edge. The fourth quarter, back in January, the first quarter in April, people were worried. You have to sort of rewind our memories back six months, three months, but investors were worried. The companies came through with pretty good results, but the stocks kept falling. Painful first half of the year for many, and so as we got into that hot, late July, that was really clutch for these companies. What were they going to report? It was really time for them to show what they were made of.
Greg Bonnell: What did they show us? What are they made of?
Vitali Mossounov: Well, the results, I would say, in absolute terms were, I don’t know, mediocre. And to be perfectly clear, it’s 7% revenue growth for the group, as a whole, which for these big tech guys isn’t anything to write home about. We’re used to 15%, 20% back in the heyday. So it wasn’t a great quarter in absolute terms. And so what hurt them? Well, foreign exchange hurt them. The weakening euro, that’s three percentage points, four percentage points of headwinds. You had, really, just the difficult comparables from the year ago. Remember, the consumer was booming in the US and all that stimulus. You just had a slowing economy, and we’ve had economists on talking about it. And the economy’s slowing. And so all these things combined to really ratchet down the growth this time.
Greg Bonnell: So mediocre. Let’s square mediocre in your assessment there with the reaction that we saw in the stock prices after they released their earnings.
Vitali Mossounov: Very different, not mediocre, and the stock prices, in a nutshell, were fantastic. I’m talking about that next-day share price reaction– really superb. You saw stocks flying. And in the markets, it’s all about expectations. And expectations, heading into — we talked about the fourth quarter earnings in January, the first quarter earnings in April. Expectations were high. But as we went through May, June, and July, what was everybody talking about? Rates, inflation, and then the r-word, recession. So by the time they reported, people were so scared. And when they still put up pretty decent numbers, mediocre but decent, the reaction was positive. They said you know what? Things aren’t falling apart. So people cheered on those stocks. Investors cheered them on, and they’ve had a pretty good run ever since, I’d say.
Greg Bonnell: That’s been a really interesting reaction. Let’s drill down to some individual names now, the biggest names in the space. Let’s start with Microsoft (MSFT).
Vitali Mossounov: Microsoft, every quarter, same narrative, this paragon of consistency. No different this time, double-digit revenue growth, double-digit EPS growth. And really, Microsoft, when they report, what everybody asks about is how is the cloud doing. The big Azure Cloud, Digital Transformation, all these buzzwords. But buzzwords aside, at the end of the day, when the quarter reporting comes, they need to put up that 44%, 45%, 47% growth. They did it. They had good guidance. They admitted there’s some economic weakness, but the market liked it. Share price reaction nice, up 6%, 7% the next day.
Greg Bonnell: OK, let’s take a look at Apple (AAPL) now. I like the way, when we show the Apple graph too– I think you’ve sort of partitioned it out the same way with those three blocks. They’re pretty telling.
Vitali Mossounov: They are telling. And Apple, again, decent results. You see that first bar up 2%. They were better than that. Now, that’s 2% after those foreign exchange headwinds. And remember, Apple couldn’t actually get its product out. Macs and iPads, they couldn’t get made, and they couldn’t get to market with all the China lockdowns. Apple’s real growth, I think, was more like 7%, 8%. Better, but again, like Microsoft, Apple only in line with expectations. But people cheered it on, the stock up again 4% or 5% the next day.
Greg Bonnell: There’s been quite a rally through the summer in the stock price, too. It’s getting back to the levels that it was at before. All that pain, all the —
Vitali Mossounov: All-time highs within sight for Apple. By the way, isn’t that surprising, given everything we’ve heard about the consumer, that an expensive consumer product, that’s the best performing stock?
Greg Bonnell: Most definitely. Now, we’re getting into the names that used to be known by another name, but now, they’re known by this name. Alphabet (GOOG) (GOOGL), of course, the parent company of Google.
Vitali Mossounov: Right, the mama stocks now, I think, overall.
Greg Bonnell: We’re MAA now. We got an M coming after this. Won’t spoil it yet, but we’re on another A.
Vitali Mossounov: So we’re talking about Alphabet, and Alphabet, I’d say, the fears were quite high. Because of course, what do they do? Well, they advertise, or they take advertising money. And guess what? When the economy slows down, there’s a three, four times multiplier in ad dollars to the economy. If businesses aren’t doing well, they’ll stop spending to get customers. They’ll tighten their belts. And so a lot of fears, but Alphabet went ahead and reported that if you back out the currency, 16% growth. And that was kind of a testament, I think. We also always question search. What’s the nature of search in our lives? And they really prove that search is that utility. Good or bad, advertisers might stop advertising other places. But when the individual tells you what they want, what they need, the ad dollars are going to go there. So Alphabet results are quite solid.
Greg Bonnell: OK. Let’s get into the M now of our list. And of course, it used to be Facebook (META). Now, it’s Meta getting us ready for the future.
Vitali Mossounov: Meta is getting us ready for the future, but they’re not quite delivering on the present. That’s a problem for us. So you see those bars are — they’re looking the wrong way. They’ve kind of been reversed there from all the other positive ones. First-time negative revenue growth, I think negative 1 or negative 2. Not very good for a company growing over 20% just quarters ago. This was a real fairy tale digital advertising story. Facebook, Instagram, now they’re struggling. There’s competition from TikTok. There’s some Apple privacy changes. They’re facing headwinds. And in the meanwhile, they’re saying spend, spend, spend, because we want to build the Metaverse. But when you spend, spend, spend, and your revenue drops, your earnings evaporate. And so the market didn’t like anything about those results. And you can see that’s a stock that’s just really struggled this year.
Greg Bonnell: Yes. Not doing all that much during the summer rally. Let’s end it off with Amazon (AMZN), obviously a huge beneficiary of the pandemic. You’re told to stay home. The mall’s not even open. You shop on Amazon. What is the stock looking like more recently?
Vitali Mossounov: Yeah, I certainly shop there an awful lot. In 2021, they grew their sales 40%. And so you’ve got, speaking of difficult comparables, some very difficult comparables. And on top of it, Amazon is having trouble making money. They over-hired. They overbuilt logistics. And when e-commerce pulled back, they said whoops. And so this quarter was a real test of how much is the consumer slowing. We’ve seen Walmart and Target with these concerning reports of inventory. Amazon, arguably the most surprising one, they came out and said, you know what? Sales are fine. There’s high single digit. We think they’ll actually grow in the teens next quarter, extremely surprising to most. And by the way, we’re getting a lot of our costs under control, at least the ones that we can control. We can’t control the oil price, but we control an awful lot. They shed 99,000 jobs in the quarter, and they’re beginning to show hope of profitability. So again, Amazon, every quarter, up or down 10, but it went up this quarter.
Greg Bonnell: Let’s talk about these businesses. Are they still the same businesses that we know, or has something changed, structurally, fundamentally about them?
Vitali Mossounov: That’s the million-dollar question. We talked at the beginning of the show, Greg, that growth was rather mediocre. It’s actually slower growth than the rest of the market. And so if these big tech folks are going to begin to be just average, then we might be overpaying for them. So I like to ask the question, are these better businesses or worse businesses than they were before the pandemic, three years ago? I think the major factor in their favor is that, very simply, behaviors change. It is a more digital world. E-commerce may have had a spike, and it’s decelerating. But I do think that consumer behaviors have permanently changed, and I think that applies to a lot of industries, including the enterprise and large companies. On the other hand, there aren’t infinite dollars out there in the world, and they did bring in a lot of extra revenues. Some of these are doing twice the pace of what they were pre-pandemic. So you’ve tapped into more of the market faster. That means there’s less to go. So we just can’t expect the same growth rates that we did pre-pandemic. In my head, it’s a debate, but I think those two do net out somewhat. And I am on, I guess, the optimistic side of the ledger that these are still solid businesses, as they were three years ago.
Greg Bonnell: Heading into this earnings season — and you and I may have had this discussion before earnings season about the P/E ratio, price to earnings. And some people thought, well, prices have come down. But maybe the earnings need to come down as well, in terms of what we think these companies can give to us. What about the valuations? Do they make sense right now, what we’re seeing?
Vitali Mossounov: We’ve seen a — funny you say that — a bit of a tick down in the earnings estimates. These companies certainly had a cautious tone. It’s better than expected, but they did talk about more foreign exchange, more consumer macro weakness. So you saw estimates ticked down but not by too much. Net-net, I think when you think of valuations, I say you’re going to be paying a premium for technology stocks over the rest of the market for the better business models and for the better earnings growth. The number one question is, what’s the premium you pay? Historically, it’s been between 10% and 40%. After this rally, it’s about a 30% premium. So you’re neither screaming at the low end or the high end of that. It’s all going to come down to execution. By the time that 2023 rolls around, can these businesses instill confidence in investors they’re going to return to that double-digit kind of growth?
Greg Bonnell: Well, let’s talk about, then, perhaps about opportunities or how we should be viewing these stocks for the second half of the year, which we’re already in the first half of the year. I always hate when I have to bring up the first half of the year because it was painful for the audience. It was painful for me, painful for you, too. What can we expect out of tech in the second half of the year? Is it going to be a bumpy ride?
Vitali Mossounov: Well, it’s funny you say. We’re already in September. The time is just flying by. Look, the market is looking forward, and I think they’ve already had a pretty good look at Q3 in the second half of the year. And we talked about inflation already moderating, talked about growth being rather mediocre. I think that is all going to persist through the second half of the year. And in fact, the market’s now beginning to think about not the second half, but 2023. I think what I like about the equation for 2023 is that growth will be a little easier to come by in terms of comparables for these companies. They won’t have that difficult comparable from the 2021 pandemic year. At the same time, they’ve all sent a strong signal that they’re going to be careful with how much they spend. So they’re going to be really focusing on the OpEx line. And to me, that might be a nice signal for the markets that we could see nice operating margin expansion and earnings growth. So the market, I think, it’s going to be a debate. I don’t think tomorrow we’re going to wake up, and the market says, all clear, tech leads the market. I think it’s going to be a debate, a tug of war as we’ve had. But there’s an interesting discussion to be had about where we go to in 2023.
Greg Bonnell: Of course, the view of TD Economics, as we heard at the top of the show, is that the chances of a recession’s basically a coin flip, right now. Are there certain kinds of tech names that fare a little bit better if growth is either slowing or right out contracting?
Vitali Mossounov: And that coin flip makes it challenging because you’re trying to forecast businesses and a lot of them cyclical. The nice thing about technology and how we approach the portfolios is there is a lot of technology businesses that are, to a great degree, disconnected from the economic cycle. Nothing ever is completely, but we want something with secular growth trends that’s going to be immune from that extreme slowdown or pick-up in business activity. So with inflation hopefully slowing, with rates finding some kind of range, and with the worst quarters behind these companies, I do find it’s an interesting setup in a lot of pockets of technology, where you have that secular growth and, potentially, a reacceleration of earnings.
Greg Bonnell: Before we let you go, I’m going to get your 30-second thought on the path forward for tech. Obviously, you said there is caution, perhaps some turbulence. What should an investor be thinking about if they’re looking at this space?
Vitali Mossounov: Well, they certainly need to be careful with timing. And I think we can see that as a case study from the first half of the year. After the sharp rally off the bottom, who would have called that? You’re basically back to February or March levels. So timing the market in a time like this is proving to be a mug’s game. It’s not working out. I think at the end of the day, it’s the first question of the segment. That’s, are these still the kinds of companies that they were before the pandemic? Is this still a technology first world? And ultimately, in practical terms, do investors believe that earnings growth will be better than that of the market? If that’s the case, if you believe that, technology has a role to play in your portfolio.
Greg Bonnell: I love hearing your thoughts. I’m going to sneak one more in. We just got this earnings season behind us. Quickly, what should we be watching when the next earnings season rolls in?
Vitali Mossounov: Well, Q3, I think you’ll get into September before these companies close their books. The same kind of fears are going to emerge. I’m quite confident in that. People are going to be worried. It’s a year of worry, and we’re not done with that, I think. These companies will have to report, and what we’re going to be watching for is put up that strong growth again. Amazon, Microsoft continue to say that things are mostly good and put up the numbers that investors expect.
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