It’s much more than just a tech rally

Good morning. The FTC is suing to stop the big Albertson’s-Kroger grocery merger. I’m not sure what to think about this. I wonder if having a bigger supermarket competitor squaring off against Walmart and other big box discounters might actually make the market healthier, but I don’t know how you figure this out in advance (I had the same question about the Sprint/T-Mobile merger). Anyway, it will be fun to watch, and I’m curious to hear your thoughts: robert.armstrong@ft.com.

It’s not just tech, and not just the US

The current rally in stocks is widely understood as driven by, or even consisting mainly in, a big upward move in Big Tech stocks. To pick one example, here is Ruchir Sharma of Rockefeller International, writing in the Financial Times about the difference between the bull markets in the US and India:

The US [rally] is a historic anomaly. It’s all about one big sector — tech — and within that sector, the few giants that have gone by many different nicknames, most recently the Magnificent Seven. These companies are getting older and larger and sucking the life out of other stocks.

In the last year, the Magnificent Seven are up 80 per cent, and account for more than half of all US stock market gains. Meanwhile, the median stock, out of the 4,700 traded in the US, is down. It’s a tale of unusually concentrated returns, further inflamed by the mania for artificial intelligence, which is seen as a boon mainly for the biggest companies.

I don’t think this is quite right. While the US Big Techs have performed incredibly, in recent months the rally has been quite broad on most measures, spanning different sectors, share types, and countries. Equities are doing well even if you take US tech out of the picture.

Timeframe is important. Sharma looks at the last year. I prefer to look at the market since last October 27, when the market broke the downtrend that had held since July. In the four months since then, the S&P 500 has risen 24 per cent. The Mag 7 is up 29 per cent (when cap-weighted, like the S&P) better than the index, but not in a different universe. The S&P 493, up 22 per cent, has had a hell of a solid run, too.

It is true that the Mag 7 have contributed a huge chunk of value created in this rally. Considering the S&P 1500 (narrower than Sharma’s sample of all public companies, but big enough to capture 90 per cent of the market) Nvidia alone has contributed a tenth of the total increase in market cap since October. The sexy six (The Mag 7 less Tesla, which has fallen) account for almost a third of all gains.

But this is a function of big tech’s huge size. In terms of percentage returns on individual stocks, the rally is broad. Small caps and value stocks have not done as well as big caps and growth, but they have done darn well:

More than 1,300 of the S&P 1,500 stocks have positive returns over the period. In the S&P 500, 64 per cent of stocks have crossed above their 200-day moving average, which is above the historical mean:

Every S&P sector has positive returns over the period. Only utilities (a fixed income substitute at a moment of high rates) and energy (beset by low oil prices) have produced disappointing results.

The breadth is global, too: European, Japanese, and emerging markets indices are all up in double digits. Among large markets, only China is performing abominably.

So, we are in a general equity rally, not a US big cap tech rally. Does the distinction matter? In general, narrow rallies make people nervous, though it is not totally clear that breadth is a reliable indicator. It is probably a goodish sign that the most recent leg of the rally has been quite broad. A rally driven by just a few stocks is vulnerable to local accidents. But context matters. Investor sentiment; economic backdrop; interest rates; earnings growth; and even valuation are also part of the picture. Still, killing the “it’s just tech” narrative is probably a good first step to understanding what is going on.

Uber’s buyback plan: what’s the return?

Some days ago I argued Uber’s share buyback plan only makes sense if its stock is cheap. Otherwise, it would be better to do something else with the money. Over the weekend, Warren Buffett summed up the point nicely in his annual letter: “All stock repurchases should be price-dependent. What is sensible at a discount to business-value becomes stupid if done at a premium.”

That is why it was distressing to hear Uber’s CFO describe the buyback in these terms: “We want to consistently be in the market. We’re going to start with actions that partially offset stock-based comp, and then we’re going to work our way up towards a consistent reduction of share count.” Uber should not want to be consistently in the market; it should not care about reducing the share count for its own sake. It should be focused on using capital where it earns the best returns.

One disciplined way to think about this (which I learned from the annual reports of the UK clothes retailer Next) is equivalent rate of return. The idea is that a buyback should generate an acceptable return compared to the alternatives, as measured by improvement to earnings per share. For any improvement in earnings per share driven by buybacks and a lower share count, there is an equivalent increase in pre-tax profit that would have produced the same improvement. That increase in profit is the theoretical or “equivalent” return on the buyback: a billion-dollar buyback that produced the same amount of EPS improvement as a $100mn increase in pre-tax profit has a 10 per cent equivalent return. You can calculate the equivalent return by dividing pre-tax profit into market capitalisation. Using Uber’s current market cap ($163bn) and the consensus estimate for 2024 pre-tax profit ($3.3bn) the equivalent return for an Uber buyback is a measly 2 per cent.

It’s not that simple, of course. Uber is betting that its profits will be much higher in a few years, and a buyback done now will have a much higher equivalent return based on those profits, even after accounting for the time value of money. But that’s just it: I can’t understand why, if the business is able to increase profits so quickly, the money wouldn’t be better invested internally. Keeping the share count down looks like an inefficient way of appeasing sceptical investors rather than the best use of capital. Wall Street suffers from perverse incentives.

One good read

Legal originalism might work better as a doctrine of a judicial minority.

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