It’s Loud Out There
How to cut through the noise to focus on what actually matters
By Josh J. Miles
These past few weeks have certainly helped us remember that the markets have a long-term bias toward moving higher (or in chart terms, up and to the right). The market (we will use the S&P 500 as our gauge for this post) has rebounded nearly 17% from its 3666.77 low on June 16, 2022, to today’s close of 4297.14 on August 15, 2022.1 While these last two months have certainly taken some of the fear out of the market, it has not wrestled the debate over what our future holds away from the bears.
I am no market savant. Therefore, I am left with the arduous task of consuming vast amounts of market research to help guide my clients and the portfolios we manage on their behalf. As an ardent believer in behavioral finance and the power of biases, I look for strategists who see the future differently than I do (to combat my strong need for confirmation bias). One such strategist is Morgan Stanley’s Chief US Market Strategist, Mike Wilson.2 Mike was recently quoted as saying, “Risk/reward is unattractive, and the bear market is incomplete.”3 What he is suggesting is that there is more risk, less reward given his belief that the new catalyst for a market reversal (to the downside) will be prompted by negative earnings revisions for the calendar third quarter ending September 30th. As you can see from the chart provided in Mike’s letter to clients August 15th (right), 2022 has closely resembled the average earnings revisions by analysts over the past five years. If this holds up, revisions to full year and quarterly earnings should come down.
What Mike argues is that this revision in earnings will be what pulls the market down as we enter the remainder of the year. Interestingly, in the same note, Mike was quoted as saying, “While 2Q earnings may seem like a win for some, the reason we saw relief was that expectations fell significantly into the quarter, a dynamic that the equity market discounted ahead of reporting season.”
For those keeping score at home, Mike believed the market over-discounted4 the risk of earnings being negatively impacted by the current state of our economy and therefore, when earnings actually came in better than expected, the market rallied. When I read this, he gives the market credit for discounting expectations in the second quarter but seems to believe they won’t discount expectations in the third quarter. Even his own chart shows that this seasonality is common and not explicitly due to the macro-economic environment we are in. What do we do with this information? Do we sell and wait for the market to come down and get a better “risk/reward” set up? Do we buy – because we are contrarians?
That is the problem, isn’t it? We have no shortage of information, opinion, data, facts and figures. It’s what we do with information and how to assimilate it to fit our decision-making that is the problem. I cannot think of an industry that can make itself look more complex and difficult than ours (finance and markets). My belief is that the biggest challenge an advisor (or investor) faces is how to make the complexities of financial planning, economics, markets, investment selection and the myriad of other financial decisions, simple. In seeking this “simplicity,” I have devoured numerous books, research studies and the like, looking for decision theory that will help quiet the noise (irrelevant information, opinions, data, facts and figures) and focus on those things that actually matter (and that we can control). What information should we pay attention to and what information is just noise?
Decision theory is the study of principles and algorithms for making correct decisions—that is, decisions that allow one to achieve better outcomes with respect to its goals. Every action at least implicitly represents a decision under uncertainty: in a state of partial knowledge, something has to be done, even if that something turns out to be nothing (call it "the null action"). Even if you don't know how you make decisions, decisions do get made, and so there has to be some underlying mechanism. What is it? And how can it be done better?
Our answer to this question will be the focus of my next post.
Best Regards,
Sources & Notes:
1 Source: Factset
2 I worked for Morgan Stanley from the merger of Smith Barney with Morgan Stanley in 2009 until we joined Raymond James in 2016. During this time, I became very familiar with Mike’s conservative approach (he might argue this point, but Morgan Stanley is currently one of the more bearish firms on Wall Street)
3 Source: Marketwatch. August 15, 2022 https://www.marketwatch.com/story/bear-market-for-stocks-incomplete-warns-morgan-stanleys-mike-wilson-11660592143
4 Discount, used in this context means that the market made investment decisions based on their assumptions of the future.
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Josh Miles and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Holding stocks for the long-term does not insure a profitable outcome. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions.
