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Weekly Update (10-26 : 11-01) - Cognitive Dissonance
· A pronounced feature of market practitioners is to explain away data that does not agree with the thesis they may hold dear to their heart. In other words, a wide body of investors have already decided on a conclusion despite the facts, and simply seek out confirming evidence through the media. This generally unscientific approach is why, at Marathon, we always go into every quarter of earnings season with an open mind and allow the evidence to help guide us towards a realistic spectrum of probabilities for what may occur in the future.
· Half of the S&P 500 has reported financial results, and earnings have been strong, beating estimates by 6% on average. That marks a strong quarter of earnings by anybody’s standards.
· Large technology companies have grown their profits and revenues handsomely, with Amazon, as an example, beating EPS expectations by nearly 50 percent, and more than tripling their Year over Year free cash flow.
· Valuation levels as of 10/26 rest at 17.1x forward earnings. While, according to our own calculation, the P/E ratio is a poor barometer of value, many other portfolio managers rely on it. If we take FactSet’s P/E at face value, the current 17.1x is lower than both the five-year average of 18.7x earnings, and the ten year average of 17.5x earnings. Traditionally, entering the market during such periods of turmoil has resulted in strong forward returns.
· Market myopia and cognitive dissonance have worked together to convince investors to keep hoarding cash and remain fearful. Fund managers have turned outright bearish, according to Bank of America. Such times, also, are emblematic of excellent investment opportunities.
· According to Jeremy Siegel, Professor Emeritus of Finance at Wharton, November is the second strongest month seasonally for returns, following April. He believes now remains an excellent time to invest new money into stocks.
· Core inflation has recently fallen to a level of 3.68% year over year and continues to fall despite turmoil in the Middle East and gas prices at slightly elevated levels.
· While the new war is worrisome, traditionally wars that remain regional in nature do not have big or lasting market impacts. Markets tend to recover their ~5% losses fully within 47 days.
· The Fed seems poised to hold steady its rate hiking campaign, as jobs data continues to soften and risks causing a recession are now appearing to be more “two-sided.” This is Fed parlance for the idea that the “jobs” part of their dual mandate is becoming as important if not more important, than their inflation mandate.
· There are many data points suggesting that the Fed could pause before inflation getting to a 2% level, including when it did so back in the Paul Volcker era.
· Only the technology and energy sectors appear to have valuation levels that are more expensive than their five and ten-year averages. Tech, which gets a lot of headlines for its expensiveness, is only one price/earnings multiple “turn” higher than average.
· Typically, during years in which the first half of the year was up 10% or more, and we get a normal third quarter correction (and years in which the market has been up 1.4% or more in the first week, coming off a down year the year prior) – in instances like these, the market tends to go up very strongly in the fourth quarter (8-9% rallies being base-case.)
· There are reasons to believe ten-year treasury rates have peaked. Last week Bill Ackman (hedge fund manager) declared he thought rates would go lower and closed out his short position in the ten-year treasury bond.
· Economic GDP growth remained strong registering at over 4%.
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