Introduction to Wall Street Whispers
Every week I do over twenty idea conference calls with institutional clients from all over the world. They range from tactical traders to strategic long only portfolio managers. I literally speak and interact with the best and the brightest that the money management profession has to offer, and it is one of the aspects of my job that I love the most.
During these discussions, the clients are certainly interested in what my research is showing and what my views are on a host of different topics. Importantly, however, I do not just present to my clients where they passively listen to my conclusions and best ideas. The time spent is usually more of an active discussion and debate where investors are also sharing with me things they are thinking, worried about, what they own, and what they are thinking about buying and selling. Sometimes clients agree with my views and at others there is significant pushback. Because I have so much client engagement, the aggregation of the meetings can provide valuable information back to me about where the dominant thoughts and positioning of the institutional investing crowd are at that moment.
I remember back when I was in graduate school and just a regular retail investor. I would wonder what it would be like to get a glimpse into what the “pros” were doing and thinking. Well, going forward, I intend to share on Tuesdays what the professional investors that I speak with are thinking and doing with their portfolios to give our FSI subscribers a peak behind the so-called institutional curtain to help our retail clients.
I hope that you enjoy our new weekly note and would love to hear from you if you are finding it useful in your investment returns. So, below is this week’s comment and within it you may see some terminology that might be unknown or confusing to you. Over time, FSI will be creating a glossary of terms/vocabulary areas and some teaching sections, but for now they are still a work in progress.
As we enter into the 1Q21 earnings reporting season with the S&P 500 making new all-time highs above 4100, there are a lot of concerns that are on the minds of institutional investors. Based on our work, the anxiety is unwarranted, but we will always keep alert for something that may change the immediate to medium-term direction of the overall equity market and the positioning for investors. We continue to remind subscribers that when one does not have a disciplined process to depend on, an investor can become a flag during a windy day being impacted by the direction of the day’s directional gust. At FSI, we use disciplined, objective, and data driven approaches to our research and idea generation to help our subscribers not let their emotions or the news story of the day lead to less-than-optimal decision making.
With that being said, this week’s comments are below, which include the questions and issues that were brought up the most often in my institutional client meetings, and I will then follow with my responses.
ISSUES
- The rise in interest rates has nearly disappeared from client discussions over the past.
- It has been our observation over the last couple of months that there was NOT excessive optimism by investors, but there was a constructive tone about the forward outlook. In my view, there has been a shift towards worry and less confidence in buying dips.
- The leadership in March and early-April has left investors to question their reopening and recovery positioning.
- As the yield on the 10-yr treasury has pulled back, there was some anxiety by clients about a potential growth disappointment.
- Similar to the last couple of weeks, I was pressed harder on my conviction level regarding my ongoing bullish views and my favorable outlooks for Value/Cyclicals over Secular Growth/FAANG, and SMid over Large had run their course and were over, which again seem to be coming from other forecasters and fears that others are fearful.
SPECIFIC QUESTIONS
- What are your thoughts on the upcoming 1Q21 Earnings season that will be beginning in earnest over the next couple of weeks?
- Interest rates have come down in early April as your forecasted. Are you worried that there may an undershoot by the U.S. economy and a bigger growth scare?
- Are you still medium-term bullish?
- Has there been any changes in your key indicators to suggest your main themes are finished?
- Value/Cyclicals over Secular Growth/FAANG
- SMid over Large
- Based on your single stock earnings revision model what jumps out the most at the moment?
MY ANSWERS
What are your thoughts on the upcoming 1Q21 Earnings season that will be beginning in earnest over the next couple of weeks?
The current consensus expectation for 1Q21 S&P 500 yr/yr growth is nearly 22%, which is impacted by the low base from last year resulting from the early COVID lockdowns. Not surprisingly, the best results are forecasted to come from more cyclicals sectors (CD, Financials, and Materials). Our work suggests that the final results will be quite robust and could end up as high as 30%. Forward guidance may not be fully optimistic, but we expect there will be a lot of commentary about less bad, clear signs of bottoming and early recovery, as well as the positive impacts of all the improved cost structures that will create significant operating leverage benefits for Corporate America. Although, there may be a handful of high-profile misses or overly conservative guidance, our research is portending final results will be quite good and help provide fuel for equity markets to keep moving higher.
Interest rates have come down in early April as your forecasted. Are you worried that there may an undershoot by the U.S. economy and a bigger growth scare?
NO. It has been our view that interest rates went up a bit too far too fast in March because of few specific macro reasons and that they would be flat to down during the early parts of April. Just as we did not think the rise in March was the beginning of runaway upward move in interest rates based on surging inflation, our view that the drift down in rates is not reflecting an impending growth disappointment. In my view, rates are heading higher from the abnormally low levels that accompanied the forced Pandemic economic lockdowns and will be normalizing during 2021, and possibly beyond. This expected rise in interest rates will not likely be in straight line, but stair stepped higher as the economic and inflation ebb and flow for the remainder of the year.
Are you still medium-term bullish?
YES, as I have been stating, my work remains quite constructive on the U.S. equity market and I have been viewing the challenging March price action opportunistically. Not only has there is little to no evidence in all of my key indicators that a major market top is imminent, but my most important tools have been getting even more bullish — HALO, HALO-2, and V-squared (see explanations at the end of the note) are all flashing positive signals and are not extreme.
Have there been any changes in your key indicators to suggest your main themes are finished?Value/Cyclicals over Secular Growth/FAANGSMid over Large
NO, there has been zero change in my key earnings revisions data that would suggest that my main themes from above are no longer relevant and that investors should reposition. What I have seen in my more tactical indicators is that preferred positioning and ideas were tactically extended and extreme on a relative price performance basis, which suggested that pauses/consolidations/counter trend pullbacks could occur. In my view, these types of moves are healthy and provide investors with a chance to raise exposure. Importantly, my work is not overly dominated by technical analysis, the macro story of the day, or tactical price movements. Thus, during times like these when there are sharp and sudden reversals in leadership, I find having a disciplined and objective process quite value added in filtering through the noise and increase in volatility. Thus, my work strongly suggests that using weakness to raise exposure in Value/Cyclicals/Recovery Plays and moving down the cap scale will reward investors with patience and conviction to do so.
Based on your single stock earnings revision model what jumps out the most at the moment?
- Energy — there has been no deterioration of the favorable readings that we have been commenting on the past several months. My work would suggest that the recent underperformance by Energy stocks has simply been a healthy pullback from tactically overbought conditions and not an END move, which is setting up as a buy the dip for the sector.
- Materials — similar to Energy, the sector continues to show strength and there are still a healthy number of interesting names in Chemicals, Industrial Metals (Copper/Steel/Aluminum), Fertilizers, and Packaging.
- Industrials — The number of higher quality Machinery and Capital Goods names remains quite broad based, as well as transportation related (Airlines, Air Freight, UBER/LYFT). Building products is also an area of strength (ALLE, AOS, FBHS, JCI, MAS). The work continues to like the three big “uglies” within the sector — BA, GE, and MMM. NEW this month is that the Defense names are now looking better, and despite our preference to be more economically sensitive there is no denying that GD, LMT, and NOC are now favorable.
- Consumer Discretionary — the work is still flagging compelling names in Auto/Related, the entire travel/vacation space (Cruise Lines/Casinos/Hotels/Travel companies), Restaurants, and many Retailers. NEW this month is that the Automotive Retailers have improved (AAP, AZO, KMX, and ORLY).
- Technology — despite the recent price volatility, the sector still shows broad based strength that is dominated by more cyclical areas including the Semi-cap equip and Chips, as well as Hardware, Electronic Equip & Instruments, Electronic Components, Electronic Manufacturing Svcs, and Tech Distributors. There were some new signs of warning that did show up in several names in Application Software for the first time that definitely caught our attention and will closely monitor. Two names that our work is strongly suggesting will start to act better are MA and V. For the LC Growth/FAANG investors, MSFT and AAPL within Tech still look quite favorable, as well as GOOGL and FB with Comm Services.
- Financials — the sector’s favorable names are quite broad based including the Banks (both money center and regionals), Investment Banks/Brokers, Credit Cards (AXP, COF, DFS), and NEW this month is that there has been some improvement in the insurance sub-industries. We have been commenting that it was our view that interest rates would be flat to down during April relative to the highs seen in March, and that this would likely lead to the sector underperforming. Similar to my comments on Energy, I am viewing this weakness simply as a healthy pullback from tactically overbought conditions and not an END move, which is setting up a buy the dip for the sector.
- The areas that have the least number of favorable names remains Health Care, Staples, Utilities, legacy Telecom, and Real Estate as I have been highlighting since April 2020. If one is looking for exposure within these sectors, there are some single stock ideas that do look like interesting opportunities, but it does take some digging.
Bottom line: Stay the course. Our main themes of higher markets, Value/Cyclicals over Growth/FAANG, and SMid over large are still intact. There may be some volatility and headline risk over the next couple of weeks as Corporate America starts reporting their 1Q21 results. We will look to buy relative weakness in the sectors/stocks that my work continues to flag as favorable and avoid the areas that have unfavorable indicators. As we shift into Spring/Summer and the likelihood that the broad country-wide vaccination deployment accelerates, the odds of moving more towards recovery rise each day. Let’s be ready to seize the opportunity to achieve superior market beating returns.
