Bigger Than The Tech Bubble
The Broad Market Index was up 0.32% last week and 27% of stocks out-performed the index.
sergeitokmakov / Pixabay – Valuewalk
Q3 2021 hedge fund letters, conferences and more
Currently, US Corporate Growth is the highest ever with sales growth over 25% at the average American company. US gross profit margins are also up and operating costs are down which means that cashflow is still accelerating at more rapid rate than sales. This is a broader and stronger acceleration in corporate cash than at the peak of the Tech Bubble in 1999.
It is likely that the recent 3rd quarter financial statement update would mark the crowning of corporate growth. The bitter end is seen by the falling frequency (or number of improving) sales growth companies. Last quarter, 75% of companies reported a rising gross margin (down from 83% in the prior period). In other words, ¼ of US companies are on a financial topline downturn while a larger number are on the tipping point. Gross profit margins continued to improve broadly with 52% of companies showing a quarter over quarter rise. Still a substantial amount of market capital; as it accounts for 62% of market capital.
Inflation Is Eminent
All these historical highs will moderate in coming quarters. We are in the early part of a Housing-&-Autos driven industrial cyclical advance.
This is the 3rd quarter of what is, historically, an 8 to 12-quarter trough to peak. Note, every such corporate growth advance since WW2 has been associated with a persistent increase in inflation.
Inflation At 6%
Demand for big ticket consumer goods will increase for as long as interest rates remain lower than inflation and financing is freely available. This has already produced an overheated recovery and measured inflation is up from 1% to 6% this year.
In such a stock-market most stocks of high growth companies will perform poorly because their relative growth falls. Stocks of high sales growth companies are vulnerable to a price decline when sales growth and profit margins drop. Many of these stocks have been strong recently.
Leverage Is Key
There is a clash building between lower interest rates and higher inflation. To manage investments through such a period, you will need a portfolio of companies that have both growth & leverage attributes. Without operating and/or financial leverage, your portfolio of growth companies cannot rise above the broad average.
It is a falling gross profit margin that needs to be avoided most scrupulously. This is evidence that the company is unable to pass on rising costs (both input and labor costs) as higher output prices. This lack of pricing power is more evident in the recent period when the frequency of rising gross profit margins was down from 69% (the highest ever) to 61%.
That is why, at least for as long as the economic acceleration persists, companies in your portfolio must have leverage attributes. With overall growth still high and rising, it is important for companies to accelerate faster. That requires operating and/or financial leverage.
What To SELL Now
The most important decision is to avoid and sell stocks of companies with unstable or falling corporate growth. The average company is still stiving on the market. Falling growth remains statistically infrequent but there are numerous companies with falling sales growth and falling gross profit margins that are surprisingly still reporting rising cashflow. Be aware!
This is an unsustainable growth pattern; these companies cannot indefinitely continue to aggressively lower operating costs to protect the bottom line. Look for cost containment weakness such as rising Sales, General and Administrative expenses (SG&A). Once cost issues make it to the bottom line and is reported to the Securities and Exchange Commission (SEC) it may be too late to sell.
Review Your Portfolio Holdings
Many stocks of companies with high but falling growth have performed well in recent months. Now is an ideal time to sell the stocks of these falling growth companies and shift portfolios towards stocks of companies with leverage and acceleration attributes.
Stocks that perform well during this broad and strong advance in corporate growth will be those that accelerate cashflow at a more rapid rate.
Only Invest In Healthy Otos MoneyTrees!
In today’s market, the most important portfolio attributes are cashflow (or profitability) and quarter-over-quarter sales growth.
The amount of relative profitability is measured and displayed by the size of the cashflow globe (or plant crown) and the color represents the overall health change. Similarly with sales growth, where the level of growth is measure by the length of the Moneytree trunk and the color represents the trend direction (darker color).
