This page discusses various current issues about stocks, industries, and other assets.
Factor Rotations: When Do Growth and Value Outperform?.
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Dr. G. Kevin Spellman, CFA
December 18, 2022
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Understanding factor rotations is paramount to managing a fund through good and bad times. This article presents the drivers of growth and value outperformance. The cycle of factor performance is impacted by four macro forces including economic growth, interest rates, market returns, and value dispersion.
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Dr. G. Kevin Spellman, CFA
April 30, 2020
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At about 2,900, the S&P 500 is only 15% off its all-time high and down just 10% for the year, but the starting points were arguably lofty levels. At its low, the market fell 35% from its intraday peak of 3,394, which is slightly more than the median bear market of 33% during the last seven recessions. The current rally implies all is now fine and well, coronavirus is just a blip, and the economy will be off to the races sometime soon. This may be hopeful thinking.
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- The market’s rally implies all is fine and well, but it is way ahead of profits
- The government came to the rescue, but this could still go on a long time
- The Fed’s liquidity injections are distorting asset prices and misallocating capital
- Fair value could be lower than the prior high even if profits fully recover.
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Dr. G. Kevin Spellman, CFA
March 18, 2020
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So much is happening, and quickly. The S&P 500 is down almost 30%, schools and businesses are closing, people are beginning to panic, and the financial markets are not functioning smoothly (stocks and safe assets are both declining). Monetary and fiscal policy are coming to the rescue, but maybe we just all need to stay home.
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- Human behaviors are following predictable patterns in response to coronavirus
- Markets are not functioning correctly – is Financial Crisis 2.0 brewing?
- Expectations started high, so the sharp correction is not surprising
- A recession could be needed to rid of excesses
- Maybe we should just stay home and watch Netflix
Economy Caught a Nasty Virus..
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Dr. G. Kevin Spellman, CFA
March 4, 2020
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The real and pychological impacts of coronavirus may drive the economy into a recession, and the markets were expecting an earnings recovery.
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Dr. G. Kevin Spellman, CFA
February 4, 2020
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Interest in ESG – Environmental, Social, and Governance – issues is growing, and for good reason. This study finds that being good to the world is consistent with being good to shareholders. Highly-rated ESG firms tend to be more profitable through the economic value added (EVA) lens. Plus, high-ESG stocks that also have high EVA Margin have historically generated above-average returns with below-average risk.
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Dr. G. Kevin Spellman, CFA
September 23, 2019
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You’ve heard of the old adage, “Don’t fight the Fed.” The Federal Reserve is a powerful force and has great influence over the economy. The Fed influences the economy through the Fed Funds Rate, money supply growth, and announcements of its intentions. The Fed is divided on whether rates will increase or decrease in 2020, but it clearly has a bias toward easing right now. Money supply is growing quicker than GDP. It normally pays to heed the direction of monetary policy.
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Does the Trade War Matter? Can the US Win It?.
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Dr. G. Kevin Spellman, CFA
July 30, 2019
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The title of this paper has two questions that may have obvious affirmative answers to many or even most readers, but this paper questions common beliefs. Given media and policy attention on the US-China trade war and how the market seems to react to every bit of news, “yes” may be the answer for many people to the first question, “Does the trade war matter?” The answer to the second question, “Can the US win the trade war?” will also be “yes” if one bases the answer on President Trump’s early explanation that the war will be easily won simply because China exports more to the US than the US exports to China so China has the most to lose by tariffs. However, the US has discovered that this war is not so easily won, and herein I explain why. I also argue that the trade war would not matter to the aggregate economy if it were not for the fact that most people behave based on their belief that it does. Beliefs cause actions, even if they are faulty.
The Time and Place for Active Management.
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Dr. G. Kevin Spellman, CFA
March 7, 2019
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The rise of passive management, index funds and ETFs, has been breathtaking. Is this just a fad, or is it here to last? I suggest it is here to stay, but there are ramifications. Certain market environments, such as those over much of the last decade, favor passive management. However, some of the conditions – low dispersion of stock returns and overall high returns – may be coming to a close.
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This article explores some reasons why active management has performed poorly over the last decade and the possibility for that environment to change. Plus, it provides evidence of what areas of the market provide the most alpha potential and best risk-adjusted returns.
The Wonderful Stock Present Under the Christmas Tree.
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Dr. G. Kevin Spellman, CFA
January 4, 2019
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I have seen several headlines to the tune, “Markets Deliver a Lump of Coal for Christmas.” However, if you have been following Coach Investing articles, you will have expected a sell off given the slowdown, overexcitement about technology stocks, high valuation, and the late cycle nature of the economy. During slowing periods, a rotation to defensive stocks is normal. However, when the correction is so strong and quick, they can create opportunities. Instead of a lump of coal, I am very excited about the stock present under my tree – some perhaps great investment opportunities.
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Alibaba is one of the strongest competitors in its diverse set of businesses. Thus, it is moat-like. It also has substantial opportunity for internal growth and for acquisitions as it builds its ecosystem. It generates substantial cash flow to pay for this growth, and it has low amounts of debt. This growth appears to fully justify the premium P/E. Plus, Alibaba’s FCF yield is about the same as the S&P 500’s in fiscal 2022 despite its above average growth opportunities beyond that year, which implies it is more than fairly priced. The correction over the last six months may be a nice gift to investors who do not yet own the stock.
Attractive Cheap, Profitable, Small Companies.
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Dr. G. Kevin Spellman, CFA
November 2, 2018
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After rallying earlier this year, small caps have gotten crushed over the last few weeks (figure 1). This is normal during the slowing phase of the economic cycle since small caps have more domestic and cyclical exposure and perhaps less certain financial stability (see Tactical Allocation Over the Cycle). It may also be deserved.
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There has been a growing number of unprofitable small companies (figure 2) that have received, but more than likely should not have, a life line. This is typical during the latter stages of an economic cycle, but it is not necessarily prudent for the long-term. Plus, the median small cap company ($100 million to $5 billion market capitalization) is more expensive than the median large cap company (figure 3) (> $5 billion in market capitalization) despite its widening net margin deficit differential (figure 4). People have been excited to take risk.
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Maybe the correction will shake out the weak small companies from the strong and lead to a more rational market? The median unprofitable small cap stock is down 10.5% from the market peak on 9/20/18, while the median profitable company is down 7.9%.
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The cheap profitable small cap company tends to outperform over time, but investors have preferred the high flyers over the last several years.
Rising Rates Catalyst for, Not Cause of Correction?
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Dr. G. Kevin Spellman, CFA
October 17, 2018
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Headlines are blaming the recent market correction on rising rates. While this may have been a catalyst for the correction, or a tipping point, it was probably not what really spooked the market.
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Over my career, I have observed that the best stocks have solid earnings growth, improving growth, are surprising positively, and price in low expectations. While economic growth is positive, the trend is toward slowing. Surprises have turned much less positive, if not outright negative. Plus, expectations, as implied in valuation, are high.
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The real skeleton that caused the correction is probably because growth is slowing while rates are rising, and since expectations are still high, surprises are turning less positive to negative.
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Happy early Halloween!
Cracks in the Foundation of Housing?
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Dr. G. Kevin Spellman, CFA
August 5, 2018
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I am super interested in the direction of the housing market. Are you? You should be.
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Housing normally contributes to a significant portion of one’s net worth. The Federal Reserve reported that housing assets were over $25 trillion in 1Q 2018, or about a quarter of overall assets, but it is even a higher proportion of median net worth (42% in 2002 according to the US Census Bureau). The NAHB notes that housing makes up about 17-18% of GDP through residential investment and consumption of housing services (rents, utility payments, etc.). However, since housing is volatile (see figures 1 and 2), it may have an even greater impact on GDP growth. When people purchase a new home or existing residence, they buy associated goods (furniture, lawn mowers, etc.) and employ homebuilders and people who make the air conditioners and other whatnot for the home. These wage-earners then spend their income (on hamburgers, cars, etc.) and influence the economy. Plus, changes in housing wealth correlates with changes in overall consumption (see this education piece by the Federal Reserve Bank of San Francisco).
What’s Up (or Down) with the Dollar?
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Dr. G. Kevin Spellman, CFA
August 4, 2018
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Currency movements drive, and are driven by, economic conditions, and have become more important due to globalization. Given the current and looming trade wars, it is not surprising that Google web search for the dollar is at an all-time high, and the dollar has risen strongly this year.
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Changes in the dollar impact earnings, can be used as a weapon, influence inflation, and can affect asset allocation. It is no wonder that it is an often talked about subject.
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- The S&P 500 generates 37.9% of revenues internationally (source: FactSet), so a rise in the dollar hurts earnings (negative relationship, figure 3).
- China has devalued the yuan by over 8% this year, effectively more than offsetting the impact of the tariffs enacted by the US (figure 4).
- A stronger/weaker dollar makes prices of foreign goods less/more expensive, and thereby influences inflation (negative relationship, figure 5). This is quite important as inflation impacts consumer spending power and Fed policy, which affects the economy.
- Movements in currency can even influence the performance of small versus large-cap stocks (positive relationship, figure 6). The Russell 2000 generates only 20.9% of its sales internationally (source: FactSet, BlackRock). Thus, small caps tend to outperform large caps when the dollar strengthens, like this year. Although, there are notable exceptions such as in 2015 and 2016 when the dollar rose and the Russell 2000 underperformed; perhaps this was because during that time earnings of more domestically and commodity and industrial focused stocks (small, Russell 2000) fell to a greater degree than large more international companies (S&P 500) as the commodity and industrial sectors fell into a “recession.”
Don’t Ride the Bitcoin Roller Coaster Blind, Consider Value
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Dr. G. Kevin Spellman, CFA
December 20, 2017
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Too many people are riding the bitcoin roller coaster blind. Owning an asset and not fully understanding its worth, or even attempting to determine its worth, and risks is like riding a roller coaster blind. You only know if you are going up or down as you feel the rush of gravity. This is an unsound way to invest, unless you are just in bitcoin for entertainment. Below, I provide a framework for valuing bitcoin; I provide a detailed look at the upside and downside of an investment.
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Dr. G. Kevin Spellman, CFA
May 14, 2018
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Technology stocks have been on fire and the FAANGs stocks are constantly in the news. Thus, in this piece of Coach Investing, I thought readers may enjoy a macro review of the technology sector and trends in overall investment spending.
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Given the hoopla over the FAANG stocks, some may believe that a winning investing strategy in technology may be different today than in the past, but after analyzing a myriad of variables from profitability to uses of capital to valuation to market cap, it appears that a successful investing strategy has not changed much since at least the early 1990s. Namely, moderation is best. The moderately valued and profitable companies that do not over- or under-invest tend to outperform. Large companies also perform best.
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This got me thinking… Is the talk of increased regulation in the technology sector reasonable? It could be if large technology firms, as they become bigger, have a disincentive to invest and limit R&D and capital spending to the detriment of consumers.
Is Amazon’s P/E Worth 11X More than Walmart’s?
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Dr. G. Kevin Spellman, CFA
June 9, 2017
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The median P/E (excluding negative earnings companies) of the top 20% of US stocks greater than or equal to $200 million market cap is 69 compared with the bottom 20% which is at 12. This 58 P/E point spread is higher than the historic average of 50 since 1994.
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What does a high P/E imply? Super rates of growth? The implied growth rate of the high P/E stocks is 15.0% and only 0.8% for the low P/E stocks.[i] Thus, the implied growth spread is 14.3% (15.0% – 0.8%), compared to an average of 14.1% since 1994. Since 1994, the realized spread in 5-year forward growth between the top and bottom P/E companies is 16.5%, thus it may surprise many people that the current implied growth spread may be reasonable.
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Amazon trades at a 205 P/E, while Walmart is at only 18X (based on 2016 EPS). This means that AMZN’s P/E is 11X Walmart’s. Is this reasonable? With some simplifying assumptions described later, to justify AMZN’s $1003.00 value (June 6, 2017), its earnings would have to grow about 61% in 2017 and fade steadily to 7% by year 10 (33% average growth for the next 10 years). Compared to Walmart, Amazon would have to grow earnings by 50% per year for over 11 years before its discounted earnings stream would be equal to a like sized investment in Walmart that grows at 5%. This could happen, but it is obviously a rosy scenario.
Financial Sector Valuation Up So Fundamentals Must Deliver
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Dr. G. Kevin Spellman, CFA
March 9. 2017
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Over the last six months, the S&P 500 Financials sector has rallied 24.2% (banks are up 34.3%) versus 8.3% for the S&P 500. This return has outpaced every other sector, and financials have also had the best return for the last 52 weeks and one month. Most of the drivers for the sector are hooking up, but valuation has also risen so earnings must now deliver to justify the outperformance.
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Earnings have been improving since the financial crisis (figure 2), and as expected, earnings growth relative to the S&P 500 is somewhat correlated with the sector’s relative returns to the S&P 500 (figure 3). The sector’s latest twelve months (LTM) earnings growth on a monthly basis has been greater than the S&P 500 since June 2015, and in February 2017 financials earnings grew nearly 8% more than the market.