Capital Investment Advisors

How The Broader Market Is Faring In The Wake Of The Facebook Plummet

Maybe you read on your Facebook feed about a stock suffering the biggest single-day market value loss in history. That stock, of course, was Facebook itself, which lost over $100B in market cap.

While the company reported $5.12 billion in net income for the quarter – amounting to $1.74 a share, up from $3.89 billion, or $1.32 a share in over the past year – that wasn’t enough to keep the online giant rocking in the free market world.

Despite that strong performance, investors are concerned about Facebook’s prospects going forward.

Facebook CFO David Wehner spoke candidly about an expected growth rate slowdown, estimated to clock in at only high single-digit growth over the next two quarters. This announcement came after Facebook announced that the number of North American daily active users has plateaued, and the number of European daily active users was down in the second quarter.

Of course, the public anger over data leaks, privacy changes, and fake news scandals didn’t help. New users have been hesitant to log in and sign up, while long-time Facebookers are signing off.

According to the Wall Street Journal, combined daily active users in both the US and Europe dropped by approximately 3 million during the second quarter. This drop was the first decline the company has had since at least early 2014. And although these markets comprise less than one-third of Facebook’s total daily active user base, they made up 72% of the company’s revenue over the past 12 months.

This news would be significant for any company, and it is especially so for a high-flying tech giant that’s supposed to be bulletproof and priced to take over the world.

Exacerbating the problem, Wehner also revealed that Facebook’s expenses are expected to grow 50% to 60% from last year. (Much of this expense growth has to do with massive new hiring and new tech investments to prevent data theft in the wake of the Cambridge Analytica data scandal.)

Reduced growth and increased expenses is not a winning formula for any company. Still, Facebook’s sales hit a record of $13 billion, or up over 40% from a year ago, meaning that, despite the tumble, Facebook remains a massively profitable company.

Let’s talk through how the broader market is faring in the wake of the Facebook plummet. For the first time in ages, the major market indices have a considerable lack of correlation, which means stocks are currently being judged less as a group, and more by their individual merit.

As a refresher, persistently high equity correlation is something that has been a plague on diversification for many years now.

Say two stocks have a perfect correlation of 1 or 100%. This number means they move exactly together, hand-in-hand. Over the past four years, we’ve seen correlations running high – around 60% – 70%. For the most part, this meant that no matter the stock, the market direction was driving the bus. So, nearly all stocks were up, or nearly all stocks were down in a given period.

Consider if utility stocks, industrial stocks, and financial stocks all moved in the same direction. In this case, the volatility mitigation of diversification (meaning its aim to insulate your portfolio from big swings) won’t be as effective. This is the place we’ve been for a long time now. But, since the start of this year, correlations have seemed to crater. We’ve seen movement from about 70% down to less than 40%. And, in my professional opinion, that’s a good thing.

This week is a perfect example of how lower correlations impact markets – the DOW was up 1.5%, and the Nasdaq was down 1%. That’s quite the spread compared to what we’ve become used to seeing.

Back to our old pal Facebook, keep in mind that the stock market wants significant growth from new companies, and it wants it like yesterday. But, for more mature companies – like Philip Morris or General Mills, or even tech companies like IBM – there is less pressure to keep massive growth rates as these companies have become fixtures of the market. In the grand scheme, Facebook is still early in its lifecycle. And to see a reversal is a market “no-no” at this point.

But is the party over for Facebook? I’ll be the first to admit that it’s tough to root for this company. Facebook is by no means politically neutral, it is fresh off a massive data scandal, we all believe it is mapping our every move, and it has been a gigantic disrupter in the media business.

Think about it. Five or six years ago, folks had no reservations about posting to or reading their feed. Now, it’s almost considered a guilty pleasure, or a downright bad habit. Over the past few weeks, I’ve read dozens of articles about the benefits of doing a “digital cleanse” of the time we spend on our phones and other devices. Facebook is always included, front and center.

So, my answer to whether the party is wrapping up is, “Probably not.” Will Facebook go the way of Myspace and just become so “uncool” that people stop altogether? Doubtful. In fact, likely not even close. But I do think the shine is off the apple.

Previous ArticleNext Article