To Our Investors and Friends,
The S&P 500 rebounded 1.8% in November, roughly 25% of what the market lost in October. Oil prices (WTI) continued to fall, ending the month down 22% to just over $50 per barrel. The 10-year Treasury Bond fell 14 basis points to 3.01%. The spread between the 2 and 10-year is now a mere 20 basis points. This flattening of the yield curve is certainly causing some investor concern. Our favorite growth proxies, the Russell 1000 Growth and Russell 2000 Growth indexes, rebounded to finish up .9% and 1.5% for the month, respectively. Weak oil, continued interest rate concerns, and worries over a potentially escalating trade war suggest that the correction that began at the beginning of the quarter may not be over yet.
We do not think we are going to have a recession, and believe the evidence so far suggests this market correction is nothing more than a pause in a longer bull market. The internet revolution is touching just about every industry in profound ways…morphing business models; replacing a focus on lumpy capital spending to more consistent services spending (the software as a service model is the best example of this); and improving management decision-making based on data. But our concern is that some of the great stocks that drove the market over the last ten years are getting tired, and their leadership is waning.
The stock that most exemplifies this change is Apple (AAPL), which fell 18.4% during the month. Apple is a mature growth company - its 9% revenue growth rate over the last 5 years is projected to slow to mid-single digits over the next few years (a 50% reduction that may still be optimistic). The company has a following amongst both growth and value investors, and likely is no longer going to lead the market. It was a standout over the last 5 years, increasing over 120% vs the S&P 500’s 53% gain. The company generated $94 billion in cash flow last year and paid out almost $14 billion in dividends (1.6% yield), while buying back $72 billion in stock. With this kind of cash generation, the stock can participate in market appreciation, but with slowing growth, we don’t think it leads anymore.
Microsoft (MSFT) is a different story and overtook Apple as the S&P’s biggest component this month. The company has produced revenue growth of around 7% for the last 5 years and accelerated to double-digit revenue growth recently as cloud revenues, which are increasing much faster than the overall company, continue to drive the business. The company generated almost $40 billion in cash over the last year, paying out $13 billion in dividends (1.7% yield), while buying back a much more modest $11 billion in stock. Microsoft is investing in its cloud business, which should bolster future gains in revenue and ultimately stock appreciation.
The market is exhibiting behavior that suggests it will consolidate well into the new year before moving higher. We think the internet-fueled business transformations ultimately drive the bull market forward, but it may take some time for investors to renew their confidence in this, given the ongoing concerns mentioned earlier. We are using this time to build positions in new, smaller businesses with great potential, that are replacements for some of our long-time winners.
All the Best to You,
AKW