Welcome to The Long and the Short of the Markets. I will post this as an occasional and potentially regular post and video about what’s happening in financial markets, and what matters for the long term?

Last week (October 23-27, 2023) was a bad week for the market. October 2023 has been a spooky month in general.

• The S&P 500 is down 4% this month, 5.9% in last 9 days
• The Nasdaq is down 4.4% and 6.8% in same spans
• The Russell 2000 is down 8.3% this month, 6.4% in last 9 days

What’s going on?

It’s Bonds Fault?

A popular explanation is treasury yields are climbing.

US 10-year up 5.9% in yield this month, 4.1% in last 9-10 days

10-year yields are at nearly 5%. Short-term yields are even higher.

This suggests two things. Market is believing in higher for longer, and that means no relief from the Federal reserve by cutting rates. Which means companies will have to pay more to borrow, straining balance sheets and making their lives harder. And means that investors can invest in, say, 5% treasury bills that come due in 3 months without taking on any risk. Why worry about the future if you can get something without risk?

What Big Tech Earnings Tell Us

But I think that is only part of the story, and maybe an excuse. Rates were high before, and the market in October has felt it more than previous months. Let’s look elsewhere.

A lot of big companies are reporting earnings. Alphabet (GOOG), Microsoft (MSFT), Amazon (AMZN), and Meta (META) went last week.

Here are their stats:

The operational performance is pretty good across the board, with META having the strongest results. The valuation doesn’t necessarily correlate to how the stocks did – AMZN and MSFT are the most expensive, but also did the best. But each of these companies has seen their stock rise a lot throughout the year.

Earnings events are usually the most ‘fundamental’ event for a company, the real news. These companies have so much going on and are followed so closely, though, that earnings are often just another incremental piece of information.

There’s a lot of talk about the Magnificent Seven driving the markets – these four plus Tesla, Nvidia, and Apple. Anybody who doesn’t own these stocks can then blame the crowding in these stocks plus the 10-year yield for all their problems. I haven’t felt that – I own Apple, but not a lot, and I haven’t had a terrible year so far. But I know that things feel that way.

Taking Another Example

When you look at individual companies, though, there are reasons specific to them. Let’s take Thermo Fisher, a leading life sciences company – they provide equipment to science companies of varying sorts. This is a big company, $169B in market cap, S&P 500 member.

It reported earnings this week. The three headline things investors look for in earnings are the earnings for the past quarter vs. expectations, the revenue for the past quarter vs. expectations, and the outlook for the next quarter or rest of the year.

TMO had a mixed bag – it beat on earnings, missed on revenue, and lowered its outlook. On a core organic basis – meaning before you factor in acquisitions and other not comparable factors, the company expects to grow 0-1% in revenue this year, and is starting to expect the same for next year.

In other words, this isn’t a very good report, and the company, considered a leader in its field, is not growing very much. These life sciences companies are still weaning a COVID hangover, as so much focus on Covid-related treatments and vaccines boosted spending.

TMO cited the macro environment several times on its earnings call, with the adjectives challenging or volatile used 12 times. So that’s one note of concern for the sector, the market as a whole, and TMO.

Cheaper Doesn’t Mean Cheap

But also, even with all this, and even with TMO’s shares dropping 7.2% for the week and down 22% year to date, it trades for 28x trailing earnings. It trades for 20x this year’s earnings, but I suspect those are non-GAAP. It’s 31x free cash flow, and that is before factoring in its debt, which isn’t atrocious but also isn’t nothing.

Reasonable people can argue over what TMO’s valuation should be. It is a leader in its field, and its field is the sort where companies can’t afford to quibble too much, because they need the equipment to be just right for trials to succeed. But, none of those numbers are cheap, and if a company isn’t growing, the market doesn’t need a lot of excuses to sell. An AI story or some other reason to believe might buoy stocks, but gravity does take over from time to time.

Look at TMO in a 10-year chart, and it’s up an impressive 340%, well ahead of the S&P 500. Look at its PE in a 10-year chart, and it’s reaching the lower end of its range, but still more or less normal.

Context Always Matters

All of this is just to say, in the short term, it seems like things are going bad for the market in October. But let’s go back to the numbers I started with. Zoom out a little, and the S&P 500 is up 7% this year before dividends, and the Nasdaq is up nearly 21%.

The story is a little different for small caps like the Russell 2000, and a little different for companies like Thermo Fisher. The small caps is its own story to break down.

But it’s helpful to always look at context. Valuation is one form of context, weird events like COVID are another distorting form of context, and history is our last useful form of context. Fall back to that context, and the ups and downs of a given week, month, or year become a little more comprehensible, or at least a lot less important.

Disclosure: Middle Coast Investing has long positions in Apple and short-term Treasury bills. Nothing in this post is or should be taken as investment advice.

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