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Growth Team Weekly Investment Insights

In this week's post, we highlight PMI readings, semiconductor weakness, updates on the labor market and oil industry, and walk through a popular approach to analyzing software companies. 

PMI Deja Vu Sends Semiconductors Falling

We experienced a bit of deja vu last week, as a weak manufacturing purchasing managers’ index (PMI) reading sent markets into a tailspin due to recessionary concerns. The reading of 47.2 indicated manufacturing activity has been contracting for five months in a row and 11 of the last 12 months.

 

 

 

 

 

 

 

 

 

 

 

 

The semiconductor industry bore the brunt of this selling activity. Within the MSCI ACWI Index, the semiconductor industry fell 6.94% on September 3. Looking at the daily returns of this industry over the last 10 years, this was only the seventh decline of more than 6%.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Perhaps more amazing, this was the fifth worst day of the last ten years, and the only days with larger declines came during the COVID-19 downturn in March 2020!

 

 

 

 

 

 

 

Due to rising concentration, the semiconductor industry may experience heightened volatility relative to history. At the end of March 2020, the top five holdings comprised 53% of the industry's weight. Today, the top five make up over 70%. NVIDIA has gone from 10% to 40% of the total industry weight.

Also similar to last month, the ISM Services PMI report came to the rescue by indicating an expansion for back-to-back months and lessening recession concerns.  

 

 

 

 

 

 

 

 

 

 

 

Unemployment Picture

We received multiple data points indicating a slowing but strong labor market. First, on Wednesday, the Job Openings and Labor Turnover Survey (JOLTS) showed fewer job openings in July than in the previous month. The ratio of unemployed people per job opening has increased to 0.9, which is a meaningful increase from the low of 0.4 in 2022 but still looks attractive relative to history when you zoom out.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

On Friday, we got the August payroll report, which showed that the United States added 142,000 jobs. This exceeded last month's reading of 89,000 but missed expectations of 165,000.

 

 

 

 

 

The combination of macro data last week wasn’t enough for the market to believe the economic picture has worsened enough for the Fed to cut by 50bps instead of 25bps. Current market pricing suggests a 70% chance of a 25bp rate cut versus only 25% one month ago.

 

 

 

 

 

 

 

 

 

 

Oil Market Update

Oil prices have been under pressure due to both supply and demand pressures. On the demand side, concerns are growing that weakening economies in the United States (see the manufacturing PMI from earlier in this post) and China will mean declining oil demand. Meanwhile, from the supply side, markets were concerned about the expiration of production cuts by the Organization of the Petroleum Exporting Countries and its allies (OPEC+) in October. However, late last week, it announced that production cuts of 2.2 million barrels per day would continue through November.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

On the topic of crude oil, Visual Capitalist put together this graphic that breaks out the usage of a barrel of crude oil. There are 45 gallons of refined product produced from a barrel of oil and over 70% of is finished motor gasoline or diesel fuel. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

What is the Rule of 40?

The “Rule of 40” is a popular metric typically used to evaluate software companies. Its basic premise is that a successful company’s revenue growth rate plus profit margin should exceed 40%. The metric evaluates management’s ability to balance growth with financial discipline.

For example, let's say there is a company with 20% revenue growth and 20% profit margins. If new management comes in and wants to ramp up growth to 30%, it will likely need to spend money (e.g., sales team expansion) that will drive down profit margins (hopefully not below 10%). Once the market is saturated and growth slows to 5%, management will pivot to a focus on profitability and expand margins (hopefully to more than 35%).

Looking at a subset of the largest software companies within the Russell 1000® Index, you can see the mixture of different growth and margin profiles and the exclusive club of companies that have managed to achieve this 40% hurdle.