Once in a while, we make a bold statement regarding a company, particularly when we are at a MAJOR secular turning point.

In this particular case, the statement is even more important as MICROSOFT CORP. is the most valuable company in the world and the first of only two companies with market capitalisations in excess of US$ 1 trillion.

In 2019, its share price has risen 40 % to new all-time highs, pulling the NASDAQ 100 Index with it as it represents 12.8 % of the index on its own.

It is also one of those 6 US tech companies that we have highlighted many times in the past as being the most expensive and the most dangerous of all large cap equity investments because of their extremely large weighting in the global indexes and in individual and institutional portfolios.

As we highlighted in our recent post WATCH FOR A BIG BREAK DOWN IN TECHNOLOGY STOCKS, the technical breakdown in the 5 FAANGS + MICROSOFT will herald the beginning of the global US bear market.

And we have probably reached that stage as we are waiting for the corporate results of the 3rd Quarter of 2019.

We are therefore recommending to

SELL MSFT US @ USD 135

Technical Analysis

The short term chart shows a clear saucer cup topping out process since June 2019 and a clear double top after a failed attempt at an all-time high in the third week of September.

Last week’s break down below the 2019 uptrend and the Short Term moving average confirmed that a top was in place and last week’s attempt to climb back above both failed.

Yesterday’s price action confirms the break and points decisively down while the Short term Moving Average is starting to roll-over and point down for the first time since January 2019 with a “Death Cross’ in formation.

Looking at the weekly chart, the break of the 2019 uptrend an ominous sign that selling pressure is gaining the upper hand. From now on, investors will be thinking about protecting there exceptional gains in 2019 in one of the best performing stock this year.

The Monthly chart confirms, if there was a need to, that MICROSOFT which has rallied from US$ 18 in 2009 to just above 140 at its July peak, a 777 % appreciation, has been in a trend-ending vertical acceleration phase that marks the end of its secular bull market.

Fundamental Analysis

MICROSOFT CORP trades at 28.6x earnings with a dividend yield of 1.5 %.

But what worries us the most is that it trades at 10.13x book value, meaning that the company’s Accounting value is at US$ 102.17 Billion, and that includes cash and intangibles, against a Market capitalisation of US$ 1.035 Trillon.

Considering the fact that the company will generate US$ 40 Bln. of profits in 2020, it will take 22 years of profits at or above that level to compensate for the premium of valuation embedded in the Price to book valuation.

Over the past five years, te PE ratio has risen from 15,2 to the current 28.6 Times and the Price to book has risen from 4 times book value, already a high valuation by any standard to 10.1 times Book Value, an unsustainable ratio for a normal and mature company.

Moreover, earnings are not expected to rise significantly. Microsoft’s earnings are expected to grow at an annual 9 % clip in the 3rd quarter and no more than 13 to 14 % in the following years, making difficult to justify a P/E ratio of 28x.

 

True, analysts will tell you that the company has a safe business model, is diversifying into new ventures that are more promising than its old MS – Windows Operating System and that it generates a return on equity of 42 %.

However, when a company trades at 10x book value, it is probably best to measure the Return on Market Capitalisation rather than the Return on Equity as this is what investors are paying when investing in the company at current valuations.

Considering an EBIT of US$ 43 Billion, that represents barely a 4.1 % return growing at barely 10 %. Nothing to write home about really.

In fact, Microsoft CEO Satya NADELLA himself declares that WINDOWS OS and Microsoft Office suite are no longer the core or the future of Microsoft despite generating most of its cash-flow and profits still. Nadella is trying to veer the company towards more growth oriented services and businesses but that will have none of the cash cow characteristics of the MS Windows and Office businesses.

The growing rift between the US an China will make Microsoft efforts to establish in China despite the high piracy levels even more difficult as Chinese computer and chip makers will move away from the Windows OS and from the MS office suites.

And finally, MICROSOFT, like all the other tech giant are coming into wider scrutiny over their use of personal data, ethics and privacy issues.

WHERE DO WE SEE MICROSOFT STOCK GOING ?

In the short term, and assuming juntas normal correction in a bull market that is still alive and kicking, the marking of the July top and September break down blow the 2019 up trend would point to a re-testing of the Medium term Moving average as was always the case in the past, and that represents a target price of US$ 110, an -18.5 % fall from current level.

But when looking at the big picture and assuming that the secular 2009- 2019 bull market in Microsoft is over and that valuations will compress as they should in such phases, the most likely re-tracement of the entire bull market would be 61.8 % or a target price of US$ 63.5 or a 53 % decline from its top.

At that level, MICROSOFT would still trade at an elevated Price to Book ratio of 6x and Price to Earnings ratio of 18.17x.

WHY IS MICROSOFT SIGNIFICANT FOR THE GLOBAL MARKET

As the world’s most valuable company and the largest component of the NASDAQ 100 Index, MICROSOFT is the tail that wags the dog of the world equity markets.

A major breakdown in its stock price ( see Technicals above ) will trigger massive portfolio liquidations and take the indexes much lower across the board, in the US and elsewhere.

The fragile state of technical affairs of Microsoft is also visible in the other FAANGS.

So we could be very close to a major breakdown in global equities as we have highlighted in our recent post titled WARNING SIGNALS…

There are a number of general factors that worry us as well

EARNINGS RECESSION

As we have highlighted in our recent posts, there is an extremely strange dichotomy in the financial markets today.

Bonds are expecting a very sharp economic slowdown and even recession with yields having come down to ALL TIME LOWS and, for the first time in history, NEGATIVE REAL INTEREST RATES in 10 Years and 30 Year Bonds !!!!!

While equity markets are hovering at ALL -TIME HIGHS, at the most elevated valuations since 2000 and 1927, not expecting a recession at all, and NOT EVEN WANTING TO TAKE NOTICE THAT WE ARE PROBABLY GOING TO EXPERIENCE AN EARNINGS RECESSION THAT HAS ALREADY STARTED THREE QUARTERS AGO.

Every time we started an Earning Recession in the past, the markets fell sharply.

Corporate Earnings have been growing at less than 5 % y-o-y for three quarters now and will decline for the first time in Q3 2019

It is extremely difficult to see how the equity markets can expect earnings to climb back up when the bond market is expecting the most severe recession since 2008 !!!!

NO CASH IN PORTFOLIOS

September, individual investors reduced their cash position to one of the lowest levels in 30 years.

And they are not alone. Every group of investors is also carrying a very low amount of cash relative to other assets. Clearly, THERE IS NO ALTERNATIVE ! TINA is here !

This is actually a very bad sign and what it means is that when the fall starts, there will be no cash and no buying power to cushion the fall. On the contrary, investors will be selling to raise cash and protect their past performances as will be the case with Microsoft when the stock starts falling.

SMALL BUSINESS OWNERS ARE WORRIED

Small business owners are people who are in direct touch with the day-to-day life of the economy and they have their finger on the pulse of consumption and investments.

The NFIB surveys of Small Business Owners measure their optimism or pessimism through a number of indicators that are summarised above.

This indicator has always been an extremely good indicator of the future health of the economy and the behaviour of the stock market.