Market Update, Opportunity in Vanity and How Good Design Can Improve Your Investing Process
No Audio this week - the Riverside app crashed at the end of the recording.
Recap of last week:
US equities advanced on Friday after positive economic data and corporate earnings results. Large caps lagged small caps: S&P 500 (+0.25%) vs. Russell 2000 (+0.44%).
Consumer discretionary (+2.27%) and real estate (+0.94%) bested the broader market indices, while energy (-1.99%) and health care (-0.69%) lagged. American Express (+10.54%) and Visa (+2.99%) led the Dow (+0.08%) higher; Intel (-6.41%) and Chevron (-4.44%) were the index's worst performers.
The Nasdaq gained 0.95%, while tech added 0.42%. The "FAAMG" stocks advanced: Meta (+3.01%), Amazon (+3.04%), Apple (+1.37%), Microsoft (+0.06%), Alphabet (+1.56%).
The VIX edged down 1.17% to 18.51. The 30-year and 10-year Treasury yields finished at 3.626% and 3.507% respectively, while the 2-year yield ended at 4.201%.
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Huge week for earnings as I return back from vacation:
The Federal Reserve is likely to raise interest rates this Wednesday by a quarter percentage point to a range between 4.5% and 4.75%, slowing increases for the second consecutive meeting.
This calculated slowdown would give officials more time to study the effects of earlier rate rises.
The next few months will all be about how much further to go and for how long.
The CBOE VIX Index closed on Friday at 18.5, below its long run average of 20. A comparison of 2021 and 2022 shows a resolutely low VIX (sub-20) is the backdrop for strong annual gains (2021) and a VIX consistently over 20 signals trouble (2022). Keeping the current US/global equity rally going requires a “no real surprises” year for either rates or corporate earnings.
Q4 US corporate earnings season continues to be disappointing, running substantially below longer-run average beat rates/amounts on both the top (sales) and bottom (earnings) lines.
Wall Street analysts expect a 3-quarter “earnings recession” (negative year over year comps) but see 9 pct positive annual growth by Q4 2023/Q1 2024. “Easy comps” are fuelling the current rally.
The S&P 500 is trading at 18.0x/16.3x analysts’ estimates for 2023/2024. If we do get strong Q4 23/Q1 24 earnings comps, that’s fine. If estimates continue to fade, it’s not.
Q4 US corporate earnings season continues to be disappointing on both the top (sales) and bottom (earnings) lines. Why is the S&P 500 up 6 percent YTD in the face of these lacklustre numbers? Mostly because investors have had the better part of a year to prepare for them.
A quick refresh on S&P 500 valuations. First, here are current price/earnings multiples based on Wall Street analysts’ estimates (page 30 of the FactSet report noted above):
2023: 18.0x consensus of $226.13/share
2024: 16.3x consensus of $250.18/share (10.6 percent higher than 2023)
18x current year earnings is relatively high, considering 10-year Treasury yields are still 3.5 percent and the S&P 500’s 10-year average PE is 17.2x (i.e., when 10-years were typically below 3 pct). This shows that markets have a high degree of confidence that the “earnings recession” we discussed in the prior point will be shallow and short-lived. And, if the S&P 500 can really earn $250/share in 2024 then stocks may actually be attractive here.
2023 and 2024:
Now, let’s assume that the Street is just slightly too optimistic about 2023 and 2024:
2023: 20.4x earnings of $200/share. This just assumes that quarterly earnings stay around $50/share all year. Q4 2022 is running $53/share, so $50/share for the 4 quarters of 2023 seems perfectly reasonably if we get a slight recession but companies control their cost structures as economic growth slows.
2024: 18.5x earnings of $220/share. All we’ve done here is assume earnings will grow 10 percent next year, in line with the 10.6 percent increase analysts expect in 2024.
US large caps look overpriced if 2023 earnings do not hold up in line with analysts’ expectations. Tying this observation into Topic #2, $50/share per quarter in 2023 would not create positive earnings comps in Q4 2023/Q1 2024. Taking away that bullish argument leaves stocks looking expensive here.
💸Reformed Millennials - Post of The Week
Story from Nick Colas at DataTrek:
Dieter Rams codified his design ethos into 10 principles, each of which starts with “Good Design Is”:
Makes a Product Useful
Makes a Product More Understandable
Thorough Down to the Last Detail
And finally, “Good Design is as Little Design as Possible”
Almost all these maxims apply to designing, trading and investment processes. A few examples:
The trading style I learned at SAC Capital in the late 1990s/early 2000s from founder Steve Cohen was the epitome of good design. When I was there, I heard a story (perhaps apocryphal) that when Steve started his hedge fund as a one-man shop he only traded one stock in the first months: IBM. He got to know the NYSE specialists, all the analysts covering the name, the investment styles of IBM’s largest shareholders, the fundaments of the business … Everything that could affect the stock on a daily basis. As he hired traders and scaled up, he expected them to know a similar amount about their sectors and names. All this was both “Innovative” and certainly “Thorough down to the last detail”. Steve also kept a very low personal profile for many years (“unobtrusive”) and, with his successor firm Point72, has been in the business for decades (“long lasting”).
Venture capitalists and emerging Tech investors follow the paradigm of “Disruptive Innovation”, itself a paragon of good design. Truly disruptive companies leverage a new technology to address an underserved part of a given market. After they gain a toehold there, they move up the price/value ladder, taking share from incumbents who will not innovate for fear of upending their existing businesses. Eventually, the incumbents either disappear or adopt the new technology and, after a time, a new disruptor eventually comes along to repeat the cycle. This paradigm is literally “innovative”, makes goods and services “more useful”, is “long lasting” and using it makes understanding the seemingly chaotic world of startup investing “more understandable”.
Every great money manager I have ever met follows an investment process that Dieter Rams would recognize as excellent design. It only takes a handful of words for them to explain why they own what they own (“understandable”). To keep their investment edge sharp (and be “long lasting” and “useful”) they constantly look for fresh information asymmetries (“innovative”). Yes, great investors often have high IQs, but it is their adherence to basic design principles that generate the returns for which they are known.
As far as a few more nitty-gritty observations about the intersection of “good design” and trading/investing, here are 3 ideas to consider:
#1: Position size. Successful investing or trading comes down to 2 things. The first is finding good ideas. The second is owning enough of them to make a difference to portfolio performance. These are very different exercises when “designing” a portfolio. Look at the composition of portfolio returns for a good versus great investor or trader and you will find that the difference is not as much idea generation as position size. This is why so many successful money managers make post-mortems a key part of their investment process. Identifying not just what went right or wrong, but also why a position was a certain percent of the portfolio, is an important part of their discipline.
#2: A little goes a long way. Just as “good design is as little design as possible”, productive trading or investing is an exercise in economy. Neither the Braun radio nor the iPod would be as useful if they were arrayed with various buttons and switches. Simple beats complex. Our maxim of “never buy a new low or short/sell a new high” is one example of a blunt-force tool that has served us well over the years. It does not always work – there is always an ultimate low or high, after all – but we prefer to let someone else find the bottom/top tick and wait for markets to confirm those are the lows/highs. Another traders’ saying also applies here: “early is the same thing as wrong.” Timing is not explicitly part of Rams’ list, but it certainly applies to investing.
#3: Thoroughness. Great industrial design is the product of numerous, carefully considered decisions. For every iconic product, there are scores if not hundreds of rejected versions and many are only slightly off the ideal. As Bob Dylan famously sang, “If something’s not right, it’s wrong”. And so it is with investing and trading, as we are all only too aware. The good news is that even the best practitioners are wrong 30-40 percent of the time. Their good calls are enough to offset their often-bad ones. Thoroughness is a thankfully relative term when it comes to investing and trading, even if it means you have to be better informed and disciplined than most other capital market participants.
Final thought: Dieter Rams’ top-10 list of good design principles is a useful touchstone for considering how to turn the old Wall Street saying that “everything comes down to process” into a more useful observation. As we once heard Steve Cohen tell a group of traders who were deep in the hole one morning during the bursting of the dot com bubble in 2000, “Don’t make things harder than they have to be”. Rams would have approved of that sentiment.
Tweet Thread of the Week:
🎙Podcast & YouTube Recommendations🎙
Derek Thompson brings on a weight loss expert to talk about the future of obesity in America. Some really great insights for those investing in biotech and pharma or those interested in weight loss.
I loved 'The Playlist' on Netflix which was inspired by the book Spotify Untold written by Sven Carlsson and Jonas Leijonhufvud. Directed by Per-Olav Sørensen, the series tells a "fictionalized" story of the birth of the Swedish music streaming company, Spotify along with its early challenges.
Steven Spielberg was on Smartless and it was a fun listen:
🔮Best Links of The Week🔮
Blood Money the story of the worlds greatest biotech investor Wayne Rothbaum - Source: Forbes.com
Canada’s Favorite Fund Manager Eric Nuttall writes about the opportunity Canada has with its energy industry. - Financial Post
Worldwide, sales of electric vehicles in 2022 passed 10% market share for the first time; 11% of total car sales in Europe (Plug-in hybrid vehicles were another >9%), EVs were 19% in China, and 5.8% in U.S. (up from 3.2% in 2021). Source: WallStreetJournal
"Investors are piling into emerging market stocks and bonds at a near-record rate, as falling inflation and the reopening of China’s sprawling economy help reverse last year’s slide. Emerging equity and debt markets have attracted $1.1bn a day in net new money this week, according to high-frequency data tracking 21 countries from the Institute of International Finance. The speed of cross-border flows is now second only to the surge that followed the lifting of lockdowns in late 2020 and early 2021, surpassing previous peaks over the past two decades." Source: Financial Times
"Stripe, the fintech company once valued at $95 billion by private market investors, will make a decision on its plans to go public within the next year, CNBC has confirmed. Co-founders and brothers John and Patrick Collison told employees on Thursday that they will set a goal of taking the company public or letting staffers sell shares through a secondary offering." Source: CNBC
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