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Weekly Update (11-06 : 11-13) US Stocks - Justifying Their Pre-Eminence
· Earnings season continues to vindicate market bulls who’ve held steadfastly to a more optimistic take on both the economy, and the stock market.
· With 81% of companies having reported earnings results, 82% of these companies are reporting positive earnings surprises, and 62% are reporting positive revenue surprises. Overall, the Q3 year-over-year earnings growth rate is 3.7%. Given that we are very late into earnings season, it seems very unlikely at this point that we could end up with a negative year-over-year quarter of growth (all information from FactSet, unless otherwise stated).
· Nine sectors are reporting higher earnings today compared to the same reading on September 30th, so there have been many positive revisions upward. Eight of eleven sectors are experiencing Year over Year (YoY) growth, with only energy, healthcare, and materials sectors showing negative growth.
· According to Morningstar Research, the market has only been as cheap as it is right now, around 11% of the time. Even when looking at the “Magnificent 7” stocks, only Apple among this cohort is estimated to be mildly overvalued on a fundamental basis (and usually Apple looks overvalued.)
· When we dig into the domestic vs international question (i.e., which types of companies are likely to outperform), we consider the most recent FactSet data. FactSet parses out data from companies that are over 50% exposed to revenue in the US, vs companies that are over 50% exposed to revenues coming from abroad. The difference is stark, the US-centric companies are growing revenues 7.9%, those who are more international are shrinking 3.8%. Granted, some of this is coming from the US Dollar. However, when we drill into earnings, US companies are growing 3.7%, while their international counterparts are shrinking 1.6%. We view this as reinforcement of our domestic bias and increasingly dangerous and fractured international world order.
· Digging into the healthcare sector, the results are highly skewed by two companies - Pfizer and Moderna, both of whom are facing very tough comparable periods from last year (also, consequently, neither of which we own in our portfolios.) The earnings of healthcare sector have shrunk by 21.1% if these two companies are included, but when excluded, the earnings would only be down 1.1%, Year over Year.
· The net profit margin in Q3 has improved from 11.6% last quarter to 12.1%, it is also above the five-year average of 11.4%. Overall, this is suggestive of the idea that perhaps a mild “profits recession” has already come and gone in the US markets. Eight out of eleven sectors are reporting Q3 profit margins above their five-year averages.
· In sum, this data looks extremely healthy, and we believe justifies the early innings of what could be a longer and stronger recovery. Stocks have rallied around 3% so far. But, if the market acts like it normally does in “a year like this” the market should rally another 5-6% by year end, at least. Usually the fourth quarter is strong, and November is seasonally the 2nd strongest month.
· Valuation levels remain very undemanding, meaning that, absent significantly higher go-forward geopolitical risk, or “Fed Risk,” it seems like there could be some more “multiple expansion” in the cards, or stocks going up because of positive investor sentiment.
· Since such periods of good investor sentiment often coincide with robust earnings, our base case remains that, as earnings continue to increase, it will justify higher than average price to earnings multiples (whereas right now we are below the ten-year average P-E.)
· Excluding “Magnificent 7” stocks, we see a market earnings multiple that is even more reasonable, close to 15x. While we believe growth stocks win long-term, in the immediate term we think the next year could favor small, mid-cap, as well as large cap value, at the margin.
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