As earnings reports roll in, it is getting more difficult for analysts to figure out the future direction of profits for many industries and individual companies. But still, complacency reigns supreme. Chip stocks are fascinating because although sales are down 15-20% for the group, the stocks rallied to all-time highs not long ago. No one seems worried.
Numerous cyclical stocks refuse to acknowledge any real concerns, though it is getting harder to avoid seeing slowing revenues in more places. According to Bank of America, downward EPS guidance were recently outpacing positive guidance by two to one.
Major technology stocks continue to drive the indices, but the breadth of the market is unconvincing. Cracks in the stories of the high-fliers continue to get tougher to ignore. Apple is selling fewer phones. The ad growth trend at Google is looking suspiciously softer. Amazon has ridden the boom in cloud computing to the land of positive earners, but growth in that sector looks to have seen its best days. Competition is ramping up in a big way as Microsoft and Oracle fight it for customers.
3M painted an unpleasant picture of the global manufacturing scene on its last quarterly conference call. Now, some “thoughtful” analysts and commentators are pointing out that buybacks drove a lot of its earnings growth in recent years as revenue growth was never exciting. As we have said before, there is a lot of EPS magic going around. Our short book includes numerous similar stories that remain buried in an ETF somewhere like Jimmy Hoffa’s corpse. One day they might actually be discovered.
It was the explosion in corporate debt and stock buybacks that drove this cycle in the U.S. just like the mortgage boom did in the last. A more cautious Corporate America because of a less certain economy and stretched credit metrics will likely be the source of its demise.
China is showing much less ability to drive growth with debt. This is key. The 10-year, $30 trillion borrowing binge there saved the globe’s central bankers from being discovered as inept more quickly. However, despite an incredible borrowing spree early this year to foster growth, it looks like the economic data is already rolling over again there. The April retail sales and industrial production numbers continued a softer trend. Globally, trade is collapsing at a fast rate that cannot be blamed on tariffs alone.
Unless one chooses to invest without any deference to historic valuation metrics, caution is in order. We are not willing to accept the prospect of low projected returns with a greater than minimal chance of a big drawdown. If history does not matter anymore, which we strongly doubt, we are still willing to avoid risk because the likely returns from betting with the crowd appear low.
Six stocks have been responsible for about 40% of the increase in the S&P 500 over the last five years and that has been hard on any investor who focuses on the value end of the equation. We have been doing this long enough to remember the last time value investors went through a similar long stretch of underperformance in the 1990’s. The pundits were quite sure value strategies were outdated then as well.
The “everything bubble” simply left out value stocks to a large degree. Now, it appears the six market darlings and many other favorites have lost momentum as they remain well off their highs during this year’s rally. The environment has a very late cycle feel to it especially when one considers that U.S. stock indices have made little, if any, progress in over a year with a lot of volatility to boot. Perhaps value investors will one day look smart again.
Remember, you can be confident that the sky is not falling, but that does not mean that you must bet the house that the highest median stock valuations ever will make for profitable investments. There is a difference between the two that rarely gets much airtime in a very short-term, surface analysis world where the dialogue is led by those with the loudest voices that often don’t do what they recommend you do.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.