David Garrity on CNBC: There’s still some clouds hanging over Facebook

Garrity: There’s still some clouds hanging over Facebook from CNBC.

With Room To Raise 3Q18 Estimates, Look For Tech Sector To Continue To Provide Market Leadership

As 2Q18 earnings season has kicked off, it is useful to quickly assess the attainability of current Street estimates in an effort to see whether analyst estimates will increase following the release of results. Currently, Street estimates for the S&P500 2Q18 results call for +20% year/year earnings growth (which will end up around +23% if companies beat by usual margin, but will be below 1Q18’s +24.8%) off +8.7% revenue growth (a record going back to 3Q11). The sectors expected to show above average growth are: 1) Energy (+143%), Materials (+49%), Telecom (+27%) and Technology (+25%). Expected 3Q18 S&P500 earnings growth now stands at +21.7% on +7.6% revenue growth. Against this backdrop, consensus Technology 3Q18 estimates call for a +15.4% EPS growth, well below the 2Q18 +25% expectation. To the extent Tech can put up better than forecast 2Q18 results, the Street has ample room to raise 3Q18 estimates and so support continued Tech sector stock leadership going into 2H18.

2Q18 Results From AMZN, GOOGL & MSFT Support Prospect Of 2H18 Stockmarket Leadership

Within Tech, note that MSFT and GOOGL both posted better than expected 2Q18 results. While AMZN’s AWS cloud service (~$6.5bn annual revenue run rate, growing ~+49% yr/yr) is 3x greater than MSFT’s Azure cloud computing platform, MSFT is posting stronger growth (~+85% yr/yr) which implies market share gains in a critical growth market and possibly sets the stage for MSFT to match AMZN AWS in size within the next 3 years. GOOGL continues to power the growth in internet advertising, despite the impact of GDPR going into effect in late May 2018 and the recent EU fine. Our expectation is the effect of GDPR will only be felt over time as it may represent a constant headwind for internet advertisers and social media companies (e.g. FB, TWTR) to overcome. Meanwhile, with the 2018 midterms elections and a relatively robust global economy, we look for Tech sector financial prospects to remain strong in 2H18.

Will Social Media Setbacks Mark FANG’s End?

While 2Q18 reporting season has been reasonably positive for the broader Tech sector, the standout disappointments from FB, TWTR and NFLX are cause for concern. With NFLX the disappointment around subscriber growth rates is likely to be moderated by the greater critical recognition of its content production and how that will serve as a traffic driver going forward. For FB and TWTR, our view is there may be longer term impairment as company managements remain under scrutiny for aiding and abetting election meddling both domestically and internationally. As such, it appears the business model of profiting from targeted internet advertising and other forms of data monetization off uncurated news feeds is challenged. With these particular issues, social media should not be considered an equal part of the broader Tech investment landscape until such time as regulatory scrutiny subsides.

Meanwhile, good for investors to bear in mind that Tech represents 26.2% of the S&P500. Five companies – AAPL (4.0%), MSFT (3.5%), GOOGL (3.2%), AMZN (3.0%), FB (1.8%) – comprise 15.5% of the S&P500. To put this in a more global context, the same companies represent 7.9% of the MSCI World Index, which is a greater weighting than that for all Japanese equities (7.5%). Note that U.S. large cap Tech has accounted for most of the upside in global equities markets so far in 2018. Our view is that the challenges facing FB and TWTR are sub-sector specific and as such should not diminish the 2H18 prospects for the balance of the Tech sector.

Blockchain Technology Implementation Will Become An Increasingly Important Corporate Profit Driver

With the U.S. economic expansion at a relatively advanced stage at 9+ years of growth, investors are eager to consider what company managements may be undertaking by way of strategic initiatives to increase efficiency, expand profit margins and sustain shareholder value. To this end, initiatives that are under development to implement blockchain technology may provide an increasing source of corporate profit improvement as we move into 2019. While still early days, blockchain technology implementation is an emerging strategic initiative that investors will observe at an increasing number of companies globally. Stay tuned.