Climbing the Wall of Worry—What Clients are Asking
Every day I have many calls with institutional clients all over the world. Their mandates are quite varied from strategic long-only portfolio managers, hedge funds, and tactical traders. During these exchanges, we have the opportunity to hear what frontline investors are thinking, worried about, and what they are buying and selling. I always find speaking with the best and brightest that the industry has to offer incredibly valuable and insightful.
The overall market is NOT extremely overvalued despite some areas showing some exuberant behavior. My research and historical work on valuation multiples continues to show that the most important factors that impact valuation levels are still at all-time favorable readings, which supports the current market P/E.
From time to time, areas of the overall equity market get tactically extended in either direction and can have countertrend price-only moves to work off their respective extremes. What this means in plain English — sometimes stocks in short periods of time can move in ways that are not directly related to their fundamentals. This can appear odd to investors regardless of their experience and if they are either retail or institutional and can cause bad decision making. To avoid this, we use our proprietary earnings revisions metric that we call Analyst Sentiment Measure (ASM) to help us determine what the dominant trend is for individual stocks and sectors.
If our earnings revisions work is supportive when price action goes against us, it is a strong likelihood the move is a countertrend move and thus the main upward price trend will return in a short period of time and this is a dip to buy. On the other hand, if the ASMs actually begin to deteriorate, the old price trend is likely over and investors should shift to selling rallies instead of buying dips. Bottomline: our works still strongly supports the Industrial sector and we expect the names to resume their outperformance. Case in point, look how DE and URI acted today.
The earnings revisions for Banks/IBanks/Asset Managers started to get noticeably “less bad” in late Aug/Sept, which was a favorable development in our investment process. Our work is still quite constructive and is strengthening, which underlies his bullish outlook for the Financials sector (XLF) and many individual bank stocks, especially relative to defensive interest rate sensitive areas (XLU and XLRE).
I reserve the right to change my mind as more evidence becomes available, but at the moment I remain quite skeptical about the prospects that a commodity SUPER cycle is beginning that some forecasters are starting to talk about more and more. With that being said, my work does support cyclical reflation plays and has led to our favorable view of the Materials sector (XLB), as well as many individual names within the industrial metals, chemicals, and packaging.
Most preferred sectors: Consumer Discretionary, Industrials, and Materials with Information Technology and Financials better than neutral
Neutral sectors: Energy, Communication Services
Least preferred sectors: HC, Utilities, Consumer Staples and Real Estate
Bottom Line: Our key indicators remain supportive of additional gains in the U.S. equity market. Despite the possibility of pullbacks, our research strongly suggests that investors view them opportunistically and raise exposures in our preferred sectors and stocks if they occur.
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