Shane Obata, portfolio manager at Middlefield Capital

FOCUS: Global stocks

MARKET OUTLOOK:

Historically strong corporate earnings supported equities this month, offsetting negative headlines which included a regulatory crackdown by the Chinese government on its tech sector and spiking COVID-19 statistics. Of the 80 per cent of S&P 500 constituents that have reported Q2 earnings thus far, 85 per cent have topped projections by an average of 16 per cent. Growth stocks outperformed value on the top line, delivering 27 per cent year-over-year revenue growth on average but value delivered much stronger earnings growth at 107 per cent. This is a function of margin improvement against a very challenging operating environment during the second quarter of last year.

Despite the robust earnings growth generated by value stocks this quarter, quality factors such as high ROA and low volatility outperformed value factors such as price-to-earnings and dividend yield. The S&P 500 Growth Index returned 3.8 per cent in July, beating the S&P 500 Value index by three per cent. Growth’s outperformance coincides with a months-long decline in bond yields, reflected in the U.S. 10-Year Treasury yield declining 25 basis points in July and 40 basis points over the last three months. The recent bond rally undercuts inflation fears and highlights mounting concerns over the “peak everything” narrative, which entails a slowdown in earnings, inflation and economic growth.

TOP PICKS:

Amazon (AMZN NASD) ($3343.86, July 30, 2021)

Short-term estimates are moving lower on retail deceleration and rising investment. That said, there is no change in Amazon’s (AMZN) long-term outlook. The e-commerce slowdown isn’t the end of the world. People are getting back outside and AMZN is lapping tough comps in the back of the year. Even so, online retail will continue to gain share as Amazon eventually surpasses Walmart as the biggest U.S. retailer. Higher investment may hurt profitability in the short run; however, it will likely deepen AMZN’s moat in the long run. Amazon already has the best logistics and will likely extend its lead with the continued rollout of 1-day shipping. Investing in cloud should also bear fruit given that cloud adoption is a multi-decade secular theme and AWS is still the leader. Another important point is that AMZN’s business is setup in a way that should allow it to further dominate in retail. The higher-margin businesses of AWS, advertising and subscriptions are growing faster than the other segments. As a result, we should see overall profitability inflect higher in the coming years. The bottom line is that Amazon remains dominant in retail, is also exposed to other secular trends such as cloud adoption and the shift to online advertising and presents clear sum-of-the-parts value in the unlikely event of a regulatory break-up.

Taiwan Semiconductor (TSM NYSE) ($115.30, July 28, 2021)

Taiwan Semiconductor Manufacturing (TSM) is the world’s leading foundry. The company controls >60 per cent of global market share and has the most advanced technology. TSM’s sustainable advantage comes from strong execution leading to consistent demand. This allows for continued investment into R&D, which allows the company to maintain its technological leadership. TSM is well positioned for long-term growth, with high performance computing expected to take over as the main driver of demand post the smartphone era. Also significant upside potential from auto electrification, etc. The bottom line is that TSM is more likely to extend its lead than to let Intel catch up.

Uber Technologies (UBER NYSE) ($43.14 August 5, 2021)

Uber (UBER) presents great value at current prices. The Q2’21 EBITDA miss was largely driven by incentives that are already paring back since the quarter ended. UBER drivers didn’t want to come back to work but this is normal given what we’ve seen across the entire labor market. Eats has done very well and Uber Pass penetration is already high (~25 per cent of global gross bookings), with retention of nearly 100 per cent. Ridesharing isn’t going anywhere. People may use Taxis here and there but this is unlikely to persist in a meaningful way once supply issues resolve themselves. Food delivery is not cheap but consumers love the convenience. The bottom line is that UBER is the global leader in two secular growth industries (ridesharing and food delivery) and should alleviate concerns about economic viability when it reaches EBITDA profitability by the end of 2021.

PAST PICKS: August 7, 2020

Alphabet (GOOGL NASD)

• Then: $1,498.37
• Now: $2,711.19
• Return: 81%
• Total Return: 81%

Costco (COST NASD)

• Then: $340.91
• Now: $441.39
• Return: 29%
• Total Return: 33%

ASML Holdings (ASML NASD)

• Then: $366.07
• Now: $788.14
• Return: 115%
• Total Return: 116%

Total Return Average: 77%

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