To Our Investors and Friends,
The S&P 500 Index (S&P 500) increased 0.6% in May as value stocks continue to move higher, while many growth companies declined for the month. Oil rose an additional 4.3% in the month to end slightly over $66 a barrel, and is now up 35% for the year. The 10-year treasury bond slightly declined in the month to 1.58%, as did the spread between the 2- and 10-year, ending the month at 144 basis points, a five basis point contraction. Value dominated, especially industrial and commodity businesses that plan to increase pricing in the current inflationary environment, a phenomenon that investors have been eager to embrace, no matter how long or fleeting such pressures remain. As a result, the Russell 2000 Value Index increased 3.1%, the Russell 1000 Value Index grew 2.3%, and growth sank…1.4% for the Russell 1000 Growth Index and 2.9% for the Russell 2000 Growth Index.
The economy is dramatically different from a year ago. The second quarter of 2020 was the worst quarter of the COVID-led recession and makes for the easiest comparisons from a growth perspective for a majority of companies, especially travel, brick and mortar retail, and restaurant businesses. In the past week, many retailer’s first quarter reports (ending in April) showed eye-popping same store sales as the recovery charges full speed ahead, boosted by a substantial fiscal stimulus check for lower- and middle-income consumers. We believe the next two quarters will be meaningful in determining what the economy looks like in the future. Some of the changes over the past 12 months might be here to stay while others we will be happy to be rid of. My enthusiasm for flying immediately plummeted last week, the first time I traveled by plane since the pandemic. LaGuardia Airport’s multi-year construction project and long security lines that left us running for our plane was a quick reminder that virtual meetings are a fantastic alternative.
“Mind is Playing Tricks on Me,” an early 90s hit song by the Geto Boys, is a reminder that our minds often alter reality to reflect our desires or fears. When faced with a new situation, our minds often distort reality to help us understand what is happening. In this letter, we are going to answer a question we are often asked: “was last year a growth bubble like the internet bubble over 20 years ago?” We suspect this view is part of the reason why growth has been so violently sold off over the last three months.
We compared the performance of leading stocks from March 1999 through August 2000 (a few months after the peak) to leading stocks from December 2019 through May of 2021 (a few months after the growth peak). We also examined the revenue growth of these same stocks over a 12-month time frame (FY 1999 and FY 2020). Finally, we compared these returns to that of the S&P 500 over the same time frame. The Four Horsemen of 1999 include Oracle, Cisco, EMC, and Sun Microsystems. The 1999 Tech Darlings include Qualcomm, Network Appliance, Broadcom, and JDS Uniphase (bring back memories?). Last year, FANG consisted of Facebook, Amazon, Netflix, and Google (Alphabet), while the 2020 Tech Darlings include Tesla, Peloton, DocuSign, and Zoom Video.
Source: Company reports and William O’Neil’s Panaray database.
So, is it Tech Bubble 2.0? Based on the chart above, it is difficult to come to that conclusion. In fact, stock performance is far more consistent with revenue growth than back in 1999. Twenty years ago, the Four Horsemen returned four times the revenue growth of the S&P 500 and the stocks advanced 17 times as much as the Index. The 1999 Tech Darlings returned 16 times the revenue growth and advanced 67 times the return of the S&P 500. This time around, FANG produced 24% revenue growth versus -2% for the S&P 500 and advanced 66% versus the 30% return of the S&P 500. The 2020 Tech Darlings produced 126% revenue growth compared to the S&P 500’s -2% return and advanced 374% versus the 30% gain of the S&P 500 over the same time frame. Did the 2020 Tech Darlings get ahead of themselves? Yes. Are they in a bubble? We don’t think so, especially if they can continue to grow into their stock prices (the 1999 Tech Darlings all saw their businesses decline over the subsequent years).
Next month, we plan to examine another popular myth… that inflation is bad for technology companies.
At Kingsland Growth Advisors, we will continue to search for and own what we believe to be the best growth companies. Investors will love these companies some of the time and favor cyclical companies or dividend stocks at other times. We think these robust business models have the potential to produce strong stock performance for the underlying shares over many years. With a long-term horizon in mind, we believe the current pullback in growth stocks affords a rare opportunity to buy some of the best companies out there at relatively attractive price levels.
All the best to you,
Arthur K. Weise, CFA