Rocky Road Investing
I recently returned from a trip to the wild northwest of Ireland. The people of Connemara were warm; the weather chilly and misty. Hot tea or cool Guinness was consumed at every stop and lively conversation wove its way among tin whistle melodies.
But I couldn’t quite take off my analyst cap, as the sharp boulders planted in unruly fashion there felt like this second quarter earnings season. During my visit, almost all the stocks in my Growth Stock Strategist and Profit Catalyst Alert portfolios reported earnings, and the ensuing changes in stock prices felt as though I was dodging those chaotic boulders. Although we saw some fabulous performers, marginal earnings’ misses were dealt sharp blows and strong results were sometimes greeted with a yawn.
FactSet, the financial data service, confirmed my gut feeling. In a recent second quarter review it noted that earnings that beat estimates in this period were rewarded with a small 1.1% gain, slightly lower than the five-year average, while earnings misses were punished more severely (down 2.4%) than the five-year average.
To be right in the stock market an analyst obviously needs to be on target most of the time about fundamental operating results of a company. However, the more important factor is to be right on the stock direction. No one cares if you get the numbers right but the stock doesn’t move as expected. When this happens, I take note.
Although the headlines are cheering about the trifecta of all-time highs being hit by the Dow, the S&P and the NASDAQ, underneath it feels a lot messier. These unexpected stumbles in stock price despite in-line number are symptomatic of nervous investors and signal some rocky times ahead.
Almost any way you size up the stock market it’s expensive. The S&P 500 trades with a trailing 12 month P/E of 19.5, well above the five year 15.9 average. This might be fine if earnings were growing faster than usual. But that’s far from the case. Collective earnings for the S&P 500 declined 1.9% for the past 12 months. Expensive stocks are burdened with high expectations, so one small whiff of disappointment can send shares reeling.
In the meantime, as the market figures out if earnings estimates will rise enough to justify prices, I’ll be working on more bearish trades for groups in long-term secular decline and rooting around in the few industries experiencing revenue growth for undervalued stocks. My mantra has always been to recommend stocks that trade with reasonable valuations, which should help soften any drop from a quarterly hiccup.
The rocky Connemara fields are segregated by stone walls and punctuated with jagged rocks. The wall next to our cottage supposedly led to a “short cut” to the local pub. Our host promised us that many an Irishman had made the journey safely after closing time but I wondered how even a sober pedestrian could safely find their way along that rocky path.
In a bull market even a drunk investor can find some stocks that will go up, but when the market is in transition, as it is now, sobriety and care are critical.