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As 2022 opened, a momentous event occurred. Apple Inc., the maker of iPhone and iPad, briefly became worth more than $3 trillion. This was only 16 months after it had become the first $2 trillion company and less than four years after it had become the first publicly listed trillion-dollar company. Of course, Apple is not alone in being worth more than $1 trillion, as its old adversary Microsoft is worth $2.5 trillion, and was briefly more valuable than Apple last October. Other members of the trillion-dollar club include Alphabet (Google) at $1.93 trillion, Amazon.com at $1.73 trillion, and electric automaker Tesla, now worth $1.2 trillion.
As respected market analyst Fred Hickey has pointed out in a recent commentary, prior to the pandemic, Apple was a slow-growing company whose revenues were dependent upon a saturated smartphone market, with revenues showing a compound annual growth rate of 2.7% between the year ended Sept. 30, 2015 and Sept. 30, 2019. Then the pandemic arrived and revenues grew 5.4% in fiscal 2020 soaring 33.3% in the year ending Sept. 30, 2021.
The combination of its first major iPhone upgrade in years (the iPhone 12 with 5G capability) together with the forced hibernation of Covid-19 lockdowns caused spending on electronic devices to soar. Even iMacs and iPads sales, which had been declining for years, grew 23% and 34.3% respectively. If Apple keeps growing at this rate, then its price/earnings ratio of 32 times 2021-22 earnings might be justified.
Apple has become the largest company in the world by market capitalization on the back of market-leading products, but it has not expanded beyond its original focus on computers, tablets, and smartphones. Rumors of an Apple car keep circulating, but it would face severe competition from established players such as Tesla, GM, Ford, VW, and the Korean and Japanese manufacturers. Virtual reality and augmented reality headsets, which are rumoured to be introduced this year, may help bring the technology into the mainstream, but this area has been a minefield for other companies as the willingness to adopt new technologies remains an issue.
Perhaps most importantly, Apple’s outperformance, together with the other FAANG+ stocks (Facebook parent Meta Platforms, Amazon.com, Netflix, Google-parent Alphabet, and Microsoft), over the last five years has driven valuations to extremely high levels for such enormous companies. While valuation on its own has never ended a bull market, once liquidity conditions begin to tighten and interest rates (the cost of capital) starts to rise, highly-valued stocks are more vulnerable as their future growth begins to be valued less richly.
With the U.S. Federal Reserve becoming noticeably hawkish, and with the diminishing effects of the pandemic allowing people to get out of their homes and start spending more on services and experiences rather than electronic devices, it seems likely that investors will not be willing to continue paying such high valuations for stocks whose growth is already slowing.
Outperformance by the big tech stocks over the last 12 months demonstrates that momentum and passive investing, which requires index funds to buy more of a company as its price increases, have driven the performance of this bull market. As the mega-cap technology plays have continued to outperform, the average listed company has lagged. In fact at the end of December as the indexes hit new highs, 334 companies listed on the New York Stock Exchange hit new lows, more than double the number hitting new highs.
Narrowing breadth (the percentage of stocks going up as a percentage of the market) is always a danger sign. If the confidence of investors in the market leaders is shaken, a steep selloff could result in a bloodbath, as occurred in late 2000, when investors had fled the internet bubble stocks that saw market leaders plummet 85%-95% over the next two years.
Investors lost money buying the broad stock market between 2000 and 2009, even after taking dividends into account. It was the worst performance since the 1930s. Taking the remarkable bull market of the last decade into account, the 20-year returns from 2000 to 2019 were the worst in the last century. Buying a portfolio of stocks that sold at lower price/sales and price/earnings ratios and higher dividend yields actually outperformed the S&P 500 Index by over 6 percentage points a year in the decade 2000-09 and over the last 20 years as well, even though value stocks have underperformed large capitalization growth stocks.
Ironically, the worst performing asset in 2021 as inflation ramped up was gold. While it’s expected that commodity prices such as oil and gas, copper and iron ore should increase strongly in an inflationary environment, gold actually fell 3%. While there have been periods when inflation was relatively high and gold has not performed especially well, such as the early 1990s, generally the historical track record is that gold will do well when central banks are expanding the money supply rapidly.
This was true both in the 1930s when the gold standard was abandoned and in the 1970s, when central banks expanded money supply in response to a quadrupling of the price of oil. It was even true in the last decade, when consistent quantitative easing (QE) policies saw gold almost double between 2010 and 2020. Even with its major underperformance last year, gold has still risen almost 50% in the last five years, admittedly only half the 105% rise in the S&P 500 over the same period, but much better than the return on cash or government bonds.
This has been reflected in the performance of gold mining stocks, like Agnico Eagle and Wesdome, which have risen over 450% and 300% over the last five years – comparable to the gains in FAANG stocks – and Franco Nevada, which has almost doubled.
It makes sense to have some exposure to an asset that has historically preserved its real purchasing in inflationary times and that is both cheap on an absolute basis and very cheap relative to its historical ranges. Having 5% of a portfolio in well managed gold and precious metals miners will both reduce volatility due to its non-correlation with the broader indexes and after its period of recent underperformance, likely to provide good absolute returns.
Gavin Graham is a veteran financial analyst and money manager and a specialist in international investing, with over 35 years’ experience in global investment management. He is the host of the Indepth Investing Podcast.
Notes and Disclaimer
Content © 2022 by Gavin Graham. This article was originally broadcast as a podcast on Indepth Investing, hosted by Gavin Graham. Used with permission.
The commentaries contained herein are provided as a general source of information, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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