Stock Market Expectations - ADV
The “market makes no sense” is something we hear often. And often it seems like that the market doesn’t react to bad news or good news the way we would expect it to.
Short term moves in the market are usually just reflecting current changes of investors’ emotions. But when we look at longer term periods, the market seems much more rational in its moves.
Stock market prices reflect expectations of various metrics- earnings, interest rates, inflation etc. If just one of the metrics ends up differently than expected, the market (excluding short term emotion driven fluctuations) adjusts accordingly. It can certainly overshoot to both good news and bad news, but over the long term it fairly represents the value of the underlying companies.
The market is up this year and investors may be wondering what is driving it so far. Again, going back to expectations, the chart below is interesting. Investors have certain earnings expectations of companies, and these expectations are priced in the current level of stock prices. All else being equal (which is rare), if earnings are better than expected you would expect the market to go up. The chart below shows that for U.S companies, 83% of companies that reported earnings in the 4th quarter of last year did better than estimates (expectations). You can also see that normally about 75% do better than expected. This may explain why the market is up the first couple of months this year.
Source: Deutsche Bank
Another important metric is not just earnings, but revenues. Earnings can be increased by cost cutting but that has a diminishing return at some point. You can only cut costs so much before your customer or employees experience a decrease in quality or service. But growing revenues are a healthier source of earnings growth, so a look at how revenues did may be even more important.
Below is a chart showing how revenues did versus expectations.
Source: Deutsche Bank
You can see that not only did companies do better than expected with their earnings, but their top line sales numbers were better also. Sixty seven percent had better revenues than expected, when historically only roughly 58% had.
So from a basic sales and earnings perspective, so the market being up this year may not be so crazy after all. We quote Warren Buffet often, and for good reason. In a 1987 letter to his shareholders, he said “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” So the market does “weigh” the earnings and sales of the underlying companies over the long term.
So far this year the market has been driven primarily by technology stocks, especially those companies associated with the expected benefit of Artificial Intelligence. And some investors are drawing parallels of this period to the “dot-com” period of the late 1990s and early 2000s. They may be correct, and we do have some exposure to these companies in your growth-oriented funds. But it is important to remember that those are just part of the market. There are many other companies that are doing relatively well and are valued much more reasonably. And we own a lot of those also.
Again, that is why we diversify– we need to own the fast growers but also want to own companies that may not have the publicity around them and therefore normally offer a more attractive valuation.
Please don’t hesitate to call us with any thoughts, questions or if something has changed regarding your goals. And thank you as always for your trust and confidence in us.
Beach
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