This week, CIO Tom Weary, CFA®️, kicks things off by sharing encouraging updates on the pandemic and our economy. He also discusses Amazon’s wildly impressive Q4 earnings as well as reports from Alphabet Inc. (Google), Sony Corporation, PayPal, and several healthcare companies (including three CEO shakeups). Last but not least, Tom explains RFA’s most recent purchase in its Core Portfolio: Ford Motor Company.

Transcript

Hi, I’m Tom Weary here at Reilly Financial Advisors with your Weekly Market Update.  It was another busy week for earnings reports, and we won’t be able to cover all of our companies, but before we do hit some of the more notable ones let’s get an update on the pandemic and the latest reading on the economy.

Recent news on the pandemic has been encouraging.  As we can see in this first chart, daily new cases of COVID-19 have dropped sharply from the recent peak over 300,000 but still remain relatively high at over 100,000.  That has led to a drop in hospitalizations, as we see in this second chart, which is putting less pressure on the healthcare system.  Daily deaths remain elevated, averaging over 3,000, but hopefully they too will drop in the near future as they tend to lag hospitalizations by a couple of weeks.  However, with the emergence of several coronavirus variants that are more contagious and possibly more lethal, there is a race to get more people vaccinated before the British, Brazilian and South African strains of the virus become widespread.  This last chart shows that about 10% of people in the U.S. have received at least one dose of a vaccine, but that at the current rate it will be September before we reach herd immunity, hence the Biden Administration’s efforts to speed things up.  We aren’t out of the woods yet, so stay safe.

We also had encouraging news on the economic front.  The Institute for Supply Management was out this week with their Purchasing Managers Index reports for January.  On the Manufacturing side, while the reading came in below expectations at 58.7, it was still clearly in a strong expansion mode, signaling strength on the industrial side of the economy.  And on the Services side, a similar reading of 58.7 was well above expectations.  This was surprising given the recent surge in COVID cases and the impact ensuing lockdown measures had on service industries.  We also had several data points on the labor market this week.  On Wednesday, payroll processer ADP reported an increase in private Nonfarm Payrolls of 174,000, way above estimates of only 70,000, and a turnaround from last month’s disappointing drop.  On Thursday the Labor Department reported initial jobless claims for last week of 779,000, which while still elevated above the pre-pandemic average of around 200,000 was a decline from recent weeks and the lowest figure since November.  And on Friday, the government reported an increase in Nonfarm Payrolls of 49,000, just below economists’ estimate of 50,000, and an Unemployment Rate of 6.3%, a drop due mostly to people giving up looking and dropping out of the labor force.  There are still more than 10 million Americans unemployed than before the pandemic hit.  On a final note regarding the labor market, this last chart shows the decline in the proportion of manufacturing jobs in America, from a peak around 40% during World War II to under 10% today.  This was a long, gradual shift as our economy evolved more towards services.  China didn’t join the World Trade Organization until 2000, and the proportion of manufacturing jobs has changed very little since then.  Manufacturing jobs were lost to robots as companies pursued automation, a trend that has been going on for decades, making U.S. companies far more efficient and profitable than they were.

This week we heard from the final two of the five Megacap Tech Titans, Amazon and Google, and they both had absolutely blowout quarters.  Amazon reported fourth quarter revenue of over $125 billion, well above estimates for $120 billion, and like Apple exceeding $100 billion for the first time, but it was the bottom line where Amazon just obliterated expectations, with Net Income of $7.2 billion versus estimates of $3.7 billion, and Earnings Per Share of over $14 versus $7.34 expected.  What is the point of being a Wall Street analyst if a company as closely followed as Amazon can just come along and report earnings double what you are projecting?  Jeff Bezos used the occasion to announce that he would be stepping down as CEO to become Executive Chairman, which surprised many although he had been scaling back his day-to-day responsibilities for some time.  It does throw a spotlight on his successor, Andy Jassy, long-time lieutenant and current head of Amazon Web Services.  AWS has been the real profit driver at Amazon.  With revenue of $12.7 billion, we can see by this next chart that AWS represents about 10% of sales.  But with Net Income of $3.6 billion, we can see that AWS generates over half of profits at Amazon.  Amazon North America may represent 40% of all online sales in the U.S. but its cloud computing operation is where it makes its money.  Google’s parent, Alphabet, reported profit of $16 billion versus $9 billion last year on revenue of $57 billion up from $46 billion a year ago on a surge in holiday spending and a global ad recovery, causing its cash pile to swell to $27 billion from $20 billion in October.  Google Cloud wasn’t nearly as successful as AWS, though, with a loss of $1.24 billion on revenue of $3.8 billion in the fourth quarter.  Scale matters in cloud computing, and Google trails both Amazon and Microsoft by a fair margin but is growing fast with sales up 47% over last year.

Sony reported blockbuster results, with sales up 10% from last year and Net Income increasing 62%, and then boosted its full-year profit outlook by a third, amid strong demand for its PlayStation 5 video game console. Sony said, however, that it was having trouble keeping up with demand due to a worldwide shortage of semiconductors.  PayPal reported quarterly earnings of $1.08 per share, 8 cents a share above consensus. The digital payment service’s revenue also topped Wall Street forecasts. The pandemic-induced growth in online shopping helped drive record payment volume for both the quarter and the full year.  As this chart illustrates, PayPal’s payment volume has been increasing rapidly, up 31% in 2020.  There are no signs of letting up as consumers continue to move away from cash towards electronic payment.

Thermo Fisher Scientific continued its string of strong earnings reports with Earnings Per Share of $7.09 beating estimates by 53 cents on sales of $10.6 billion up 55% from last year and beating expectations by over $1 billion.  The company achieved very strong growth in the fourth quarter, generating $3.2 billion of COVID-19 response revenue and accelerating growth momentum in the base business.  Merck reported fourth-quarter earnings and revenue that fell short of estimates even as sales of cancer drug Keytruda grew 28% to nearly $4 billion. Per-share profit was $1.32 on $12.5 billion in revenue. Merck forecast full-year 2021 earnings which were higher than analyst expectations.  The company announced that Merck Chairman and CEO Ken Frazier is retiring. He will be succeeded as CEO on June 30 by CFO Robert Davis.  Frazier, one of the few Black corporate leaders in the U.S., has served as Merck’s CEO since January 2011.  And Defensive Portfolio holding HCA, one of the largest hospital operators in the U.S., reported earnings of $10.93 up from $10.07 last year even as admissions dropped almost 5% thanks to revenue per patient rising over 10%.  Investors rewarded the stock as analysts raised their estimates.

On Friday we sold our position in Allegion in the Core Portfolio and replaced it with the Ford Motor Company.  Ford is a turnaround story that should benefit from its efforts to remake itself along with the economic rebound and pent-up consumer demand.  This fits in our theme of Overweighting Consumer Discretionary stocks to participate in an economic recovery while seeking Value in an expensive market.  Ford has been trimming models and geographies in an attempt to become more profitable, an effort that was complicated by the pandemic.  On Thursday Ford reported results which surprised the market, with a profit on adjusted earnings whereas analysts were expecting a loss, indicating that the turnaround is working.  Its F-150 pickup truck has been the best-selling vehicle in the U.S. every single year for the last four decades; recent results have been held back by a lack of F-150 inventory due to a shortage of semiconductor chips.  The company is emphasizing electric vehicles going forward, due not only to the success of Tesla but also rival General Motors recently announced their goal of being all electric by 2035.  Ford just introduced an all-electric version of the iconic Mustang with the promise of producing electric versions of all popular models.  They also announced plans to invest $22 billion in the development of Electric Vehicles and $7 billion in Autonomous Vehicles.  Ford’s stock is cheap and we look for the dividend to be re-instated at some point, given the influence of the Ford family.  While the company has significant debt it also has cash on the balance sheet equal to its market capitalization.  We are selling Allegion, a maker of locks and security systems, given our investment discipline of maintaining a focused portfolio, forcing us to part with our least favorite idea when a better one comes along.

So, what does it all mean?   There are hopeful signs regarding both the pandemic and the economic recovery, but we aren’t out of the woods yet.  There is a race between rapidly mutating variants of the coronavirus and public health officials trying to get vaccine into arms.  In the meantime, many of your companies are reporting truly stellar results.  CEOs at Amazon, Merck and United Healthcare all announced their plans to step down this week, so as Heraclitus told us “Change is the only constant.”  We will stay on top of all the changes for you.  So, please, sit back, relax, enjoy the Super Bowl this weekend (Go, Chiefs!) and join us again next week for the RFA Weekly Market Update.

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