Making sense of the markets this week: August 2, 2021

Photo by Roberto Cortese on Unsplash

Each week, Cut the Crap Investing founder Dale Roberts shares financial headlines and offers context for Canadian investors.

Shopify rings up profits, CEO becomes the richest Canadian entrepreneur

Shopify, the Canadian tech darling, has increased its lead as the most valuable company in Canada. Shopify reported this week with revenue and earnings that topped expectations. Quarterly revenue surpassed $1 billion (at $1.11 billion) and quarterly profits climbed. According to the Shopify press release, net income for the second quarter of 2021 was $879.1 million, or $6.90 per diluted share, compared with net income of $36.0 million, or $0.29 per diluted share, for the second quarter of 2020. Q2 2021 net income includes a $778 million unrealized net gain on our equity investments. Shopify earned $2.24 per share on an adjusted basis in the quarter ended June 30, including gains on equity investments, up 113% from a year earlier. Shopify sets up e-commerce websites for small businesses, and also enables digital payments and shipping. The company is number two in North America with respect to e-commerce services, behind the behemoth Amazon. It’s estimated about 10% of all e-commerce traffic in the U.S. goes through stores hosted by Shopify, second only to Amazon.com Inc.’s 39%. On my site, I provided an example of how Shopify enabled a Canadian craft brewer not only to navigate and pivot during the early days of the pandemic; the Etobicoke, Ont., company actually increased sales and profits thanks to Shopify. The company now has the greatest weighting on the Toronto Stock Exchange—it’s the most valuable company in Canada, having surpassed Royal Bank of Canada for that title. Given its incredible success, that stock can certainly drive the market indices. If you take a dividend approach, you’re missing out on this incredible growth story. Readers will know that I’m a big fan of the juicy dividend slant for Canadian stocks. But we might also include the growth kicker of the burgeoning Canadian tech sector that includes many incredible success stories (although Shopify almost dominates that index ETF). It has been reported that CEO Tobias Lütke is now the richest Canadian. According to the Globe and Mail (paywall)…

“Mr. Lutke’s stake in the e-commerce software provider is now worth US$13.3-billion, or $16.7-billion in Canadian dollars. In addition, stock sale records show Mr. Lutke has generated gross proceeds of US$490-million since the beginning of 2020 by selling Shopify shares.

“His ownership stake likely makes Mr. Lutke the richest Canadian, and it certainly makes him the wealthiest Canadian company founder who has created his own fortune. It has taken Shopify and 40-year-old Mr. Lutke just 16 years to amass his billions. His stake was worth around US$2-billion just over two years ago.”

The stock fell 1.1% on the earnings release, and continued to fall on Thursday and into Friday as I write this post. In the bigger picture, it’s up some 355% from the beginning of 2020. Will Shopify be another tech-darling flash in the pan? Canadians (and Canadian markets) have been burned in the past by Nortel and BlackBerry. One crash and burn by Nortel, and a crash and fizzle by BlackBerry. It remains to be seen if the company has sustainable moats.

Canadian retail sales are back up after two monthly declines

It may be no surprise that retail sales continued to struggle in May, as much of the country continued with some form of in-person shopping restrictions. Retail sales in Canada declined for the second month in a row after two straight months of gains. It has been more than a rocky road of recovery, post-COVID. Canadian retailers have not been able to gain any traction as they’ve had to experience an open-and-shut environment thanks to lockdowns put in place to battle the pandemic spread. The 2.1% decline in retail sales in May came as many retailers continued to face those closures during the third wave of the pandemic. CTV news reported for May…

“The biggest drop was recorded at building material and garden equipment and supplies dealers, which fell 11.3%.

“Sales in the clothing and clothing accessories category declined 11.2%, with nearly a quarter shuttered for an average of six days during the month. Within the subsector, clothing stores saw an 11.6% decrease in sales, falling to their lowest level since May 2020.

“‘Apparel sales have continued to languish throughout the pandemic and have been largely impacted by changes in consumer behaviour,’ [Michelle} Wasylyshen with the retail council [of Canada] said. ‘We are hopeful that this sector will rebound in the months ahead as offices reopen and people return to work’.”

And, as expected, as restrictions were lifted we started to see some very positive retail numbers. In the Financial Post, based on preliminary estimates… “‘The good news is that provincial re-openings mostly began in June, with the positive impact on retail sales reflected in Statistics Canada’s preliminary estimate’,” Rishi Sondhi, an economist at Toronto-Dominion Bank, said in a report to investors. As capacity constraints on retailers have further loosened in July, another gain is likely in the cards.” And June mobility numbers offered a bright light for malls and retailers.

“The June sales estimate is in line with positive employment numbers for the same month showing a gain of 230,700 jobs. Mobile-phone data also showed foot traffic in clothing retailers was up 44% in June from 2019 levels, suggesting Canadians are eager for in-person shopping.”

But perhaps our spending patterns have changed forever? Here is a lighthearted post on what we’re never spending money on again. In some cases we might revolt against the “forced” COVID spending patterns, while on the other hand we’ve learned to live without many of life’s extravagant trappings. It will be more than interesting to watch the spending patterns of Canadians coming out of the pandemic. I will be keeping score in this space. This tweet suggests that the move is on to buy experiences and fun. We can’t wait to leave the house…

Great for retail, not so good for streaming services. #economy #recovery #Canada pic.twitter.com/5HMTFt7Dvd
— Michael A. Gayed, CFA (@leadlagreport) July 26, 2021

I write this post from Charlottetown, P.E.I. We were out for a patio dinner last night and the restaurants were full, inside and out. And Victoria Row, the vibrant restaurant and entertainment hub, was bursting with energy and joy with Canadians enjoying their freedom. There was hardly a mask in sight. Masks are optional indoors. It was a great feeling, to get somewhat back to normal. Of course, the East Coast and especially P.E.I has done a great job of keeping the pandemic at bay. Here’s my tweet as we entered the island. We had to preregister, provide proof of double vaccination, and we were also tested at the checkpoint:

P.E.I COVID checkpoint. We get tested too. pic.twitter.com/nC21AIp6d3
— CutTheCrapInvesting (@67Dodge) July 29, 2021

One step closer to earnings peak

Last week our look continuing at earnings season queried whether this one might deliver earnings peak growth rates. Here’s another chock-full report courtesy of Schwab; are we one step closer to peak earnings growth? From that post …

“In what shaped up to be a very impressive first half of the year for both the economy and stock market, stellar earnings growth has been a key ingredient. Coming off stronger-than-expected S&P 500 earnings growth of 53% (year/year) in the first quarter, second-quarter earnings are currently anticipated to grow by 78%, the highest since 2009. Though less than half of companies have reported, the expected growth rate is already higher than the initial consensus estimate of 65%.

“As was also the case in the first quarter, the beat rate—the percentage of companies reporting earnings growth higher than analysts’ estimates—remains quite high at 89%. In a typical quarter (since 1994), 66% of companies beat estimates; and over the past four quarters, the beat rate has been 83%.”

In that post you’ll see a fascinating table with the recent earnings growth and the estimated earnings growth (by sector) moving forward for the quarter to the end of 2022. The table shows the overall earning growth rate by quarter and the estimated growth rate decline after this Q2 reporting period. Even more interesting is the sector breakdown. We see those cyclicals, especially energy, leading the charge over the next many quarters. Projections for the energy sector are at 1076.6% for the full year (FY 21) and 29.6% for 2022 (FY 22). Industrials and consumer discretionary stocks also lead the projections for the remainder of 2021 and 2022. There might still be potential value in those sectors. As for the overall U.S. market move, that Schwab post shows how stock prices can soften along with earnings growth. And while the market is certainly more than expensive, the post provides a chart demonstrating that robust earnings growth can help to bring down those excessive valuations. But that is a tall order given the current valuation levels. Right now we have a negative real (inflation-adjusted) earnings yield for U.S. stocks. This tweet shows how the mega techs (while expensive) continue to deliver on the earnings front, but they have reached what appears to be a near term plateau:

Apple, Alphabet and Microsoft brought in after-tax profits of $56.8 billion last quarter, 30% more than analysts predicted. The figures were “absolutely stunning." https://t.co/fCEqTawxW8 pic.twitter.com/MoOuHeYSPq
— Lisa Abramowicz (@lisaabramowicz1) July 28, 2021

I’m more than happy to hold Apple and Microsoft. Amazon completes the Big 3—the three most valuable companies on the U.S. stock market. We’ll leave the final word and sensible summary to that Schwab report …

“Market behavior could become choppier as earnings growth slows; with continued, large swings in sector leadership (on a day-to-day and week-to-week basis). Investors’ best protection against volatility continues to be diversification across and within asset classes, and discipline around periodic rebalancing.”

What’s going on with the crackdowns in China?

Chinese stocks continue to fall as the Chinese Communist Party (CCP) cracks down on many national and foreign business interests. Emerging markets, led by China, offer incredible diversification and growth potential. But recent developments demonstrate the risks of investing in more unstable nations, and a country such as China that is under communist rule. While China craves economic growth, it is a one-party system and what that party says, goes. They are not always business-friendly. With this commentary on Seeking Alpha…

“Sweeping crackdowns across China are continuing to send shockwaves across financial markets, with investors finding themselves in the firing line of some of the nation’s hottest sectors. Shares of Tencent fell 10% on Monday after Beijing ordered the company to give up exclusive music licensing rights, food delivery companies such as Meituan were also targeted, while education stocks like TAL Education, New Oriental and Gaotu Techedu slumped about 25% each amid a ban on for-profit tutoring. In fact, the Nasdaq Golden Dragon China Index—which tracks 98 of China’s largest firms listed in the U.S.— dropped 8.5% on Friday and another 7% on Monday, marking the biggest two-day selloff since ’08.”

And also on Seeking Alpha…

“Beijing has tolerated conventional regulations on certain sectors in the past, the government now looks ready to kill whole companies or entire industries. One doesn’t have to look far to the recent pulling of Ant Group’s IPO or the DiDi Global fiasco that shook the investing world earlier this month. China has pointed to financial risk, antitrust concerns and national security violations, but its acceptance of stockholder pain for long-term social control appears to have some market participants reassessing Xi Jinping’s Communist Party.”

In fact, Cathie Wood who runs the more than successful Ark Investments, has bailed on Chinese stocks entirely. This is an important story to watch in the coming weeks. It is perhaps an ongoing and acceptable risk when investing in emerging markets. Dale Roberts is a proponent of low-fee investing who blogs at cutthecrapinvesting.com. Find him on Twitter @67Dodge.

About Dale Roberts

Dale Roberts is a former investment advisor and proponent of low-fee investing. He created the Cut The Crap Investing blog in 2018. Find him on Twitter for market updates and commentary, every day.

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