20 May Stay Away From Grisly Bears
Investors have pulled more than $60bn out of US equity funds since the start of this year. Outflows in the 2008 financial crisis were $85bn and $65bn during bear market of 2002. Flow data for 2016 is magnified given companies themselves are planning to buyback over $600bn in shares this year. At the same time gold is up 21% y-t-d capturing almost three quarters of all flows into commodities. Rising U.S. rates, a strong dollar and benign global inflation have traditionally flashed sell signals for bullion. Crisis remains a rationale for gold’s ascent but where and which one(s) is unfolding: debt, negative interest rates, conflict..? Carl Icahn is betting on a market crash and investors could pull $500bn out of hedge funds in 2016 according to the New York Post. Sentiment is extremely negative and investing in the stock market appears to be a bad idea to many investors at the moment. But such uncertainty creates opportunity and risk is the price you pay for prosperity.
Despite the overwhelming tone, U.S. market behavior has been fair and reasonable. Since Q4 2014 when the fed ended its QE3 program, the S&P500, give or take a few percent, is essentially flat. The period has been interspersed with 3 scary corrections including the largest swoon in January/ February of this year but each event was followed by swift unexpected reversals. Warren Buffet was correct, “What we learn from history is that people don’t learn from history”, to the misfortune of many hedge fund managers.
Many cite the Fed as the market’s party pooper but look more closely and the real reason for the S&P’s trajectory over the past 18 months has been earnings. Coincidently or not S&P earnings peaked in Q4 2014 at $119. In 2015 earnings registered $115 and our forecasts suggest $118-$120 for 2016. Here lies the answer to market performance, certainly not a reason for celebration but neither for the kind of turmoil many are forecasting and dreading. That said if passive investors are to have any success this year they had better hope that earnings revisions move higher in the coming quarters because multiples are not going to expand in such a fearful environment with interest rates increases sprinkled on top. So what is going to drive earnings higher? 1. Global growth 2. The dollar 3. Oil prices, without these your S&P 500 ETF is dead in the water.
As 2016 unfolds and we look towards 2017, hope alone that earnings will rise will not to be a path to fortune. We have two encompassing conclusions regarding the earnings problem: 1. Companies that take market share will sustainably grow earnings 2. In a zero interest rate world investors will have to pay more for such companies. There are great companies in the U.S. and around the world that are flourishing despite the slow economic backdrop and the many uncertainties that pervade. Companies successfully growing their market share are innovators with loyal enthusiastic customers, financially strong with pricing power, and in most cases dominate in their industries. They can out muscle the competition and deliver appreciating earnings and subsequently higher stock prices. Investors should take comfort that such companies will provide the surest path to investment success over the long-term. We call them Bulldogs.
In the short-term, algorithms, emotion and institutional investors will eat amateur traders for breakfast. However, over the long-term the nonsense of minute-by-minute market information is superseded by the true results of the world’s great companies. Identify, validate and stay on top of the best and the short-term pain of volatility will give way to the assurance of hard fought reward.
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