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Second-quarter earnings season is about to heat up, and it will help set the tone for stock returns for the second half of the year. But this has been an atypical year, and emotions, rather than fundamentals, may take over and drive the market more than usual this time around.
That gives us a chance that, by overlooking short-term volatility and maintaining a focus on company’s fundamental prospects, we can find some stocks that get unfairly beaten down and grab up some bargains.
Look, I’ve noticed — like a lot of you have — that the tone in the opinion-o-sphere has evolved into a nervous anticipation of the Next Big Setback. I realize there remain significant macro-level threats to the continuation of the equities bull market. The biggest threats come from the action (or inaction, or “too late” action) of central banks in setting the level of interest rates — spurring on economic growth, but potentially also igniting inflation. And this situation has many investors fearful that, as the market keeps ticking up, the underlying company fundamentals simply do not support the trend.
This is a concern I take genuinely to heart, and which I divine as I interpret the evolving results of the Weiss Ratings model. As I have pointed out over the past few weeks, though, my concern over a market that was continually rising while the Weiss Ratings set deteriorated has been replaced by a rising optimism that the guiding principle of my own service — the Weiss Million-Dollar Ratings Portfolio — is now bottoming and primed to turn back up, even if we should hit a speed-bump in terms of prices.
What that means — succinctly — is that my confidence in the short-term tactic of adding to economically sensitive sectors is gaining in strength. I’ve mentioned in previous posts that energy, financials and consumer discretionary looked to be in good shape, ratings-wise. I’ve further indicated that despite its volatile nature, the tech sector has some gems buried within in that can shine even if that sector dulls in the short term.
Longer term, it’s always fundamentals that drive stock prices. As a smarter man than I — John Maynard Keynes — elucidated, asset prices are driven by both the underlying microeconomics of individual firms as well as by “animal spirits,” which essentially represent investors’ expectations for the future of those same fundamentals.
Future expectations can change with regularity, and during earnings season the difference is on full display. And this is where I think using a quantitative system as an aid to stock-picking proves itself most useful.
Consider one of the WRP holdings that reported overnight last night — Intel (INTC, Rated A-). When I first purchased the equity for the Portfolio, it carried a Weiss Rating of B, and that rating captured not only how well the company had done in the past (taking into account not only its salad days of yore, but also the harder times it had fallen on in recent years), but also provided a window into the market’s expectations for the future of company fundamentals.
Whenever I spot what could be a disconnect between what the crunched numbers tell us and what the market is currently telling us — Â a main factor in my interest in INTC — I dig deeper to find out if the market might be under- or overestimating individual equities. In this case, it seemed to me that on a fundamental basis, the market was underestimating the firm’s chances to return to a solid growth path — either over the short or medium terms. And so I took a position, added to it when it trailed tech peers in the days after my initial purchase.
The stock has since turned out to be a solid contributor to Portfolio performance, and a good example of how the anticipation of better times ahead fundamentally translate into outsized stock performance.
Of course, this method of picking stocks is not always correct — I’ve certainly picked some clunkers in the past that passed the quantitative and fundamental analytical processes. However, using the discipline enforced by a quantitative model definitely helps encourage actions that would be difficult to take if I were picking stocks based on purely short-term, technical or sentiment-based analysis.
Bottom line, we’ve seen that tech is a wildcard, but there are some terrific stocks in there to choose from. We’ve also seen that after some mild deterioration; energy, financials and consumer discretionary provide some other areas of interest for longer- and short-term-focused investors. In energy, the market is expecting firms to post the largest sectorial earnings growth among the 10 S&P sectors in the quarterly reporting season underway — so my view is that it is energy’s game to lose. What I mean by this is that short-term movements are often dictated merely by companies’ results versus expectations. So, shortfalls will likely not be kindly viewed.
On the other hand, financials, and to some extent, consumer discretionary, are in the position where it is their game to win. This means that financials — where we’re expecting that largest decrease in results versus the same period last year, has a better-than-average shot at surprising investors to the upside. Consumer discretionary is more on the “game to win” side as well, which is why my focus during earnings season will be to find those equities that have a good chance of beating expectations going forward.
Remember, this earnings season volatility should mostly be viewed as a temporary situation. In some cases, it will give us the chance to pick up great stocks on the cheap, while in others it may be informative regarding a longer-term trend. Using a disciplined guideline will hopefully help me in discerning between the two.
Best,
Don Lucek
