Joel's note: Considering the recent volatility in the market, we're stepping aside from our normal format of the Altimetry Daily Authority today to focus on a broader view of the macro environment.
The volatility over the past week has a lot of investors spooked...
We spend a lot of our time with our institutional clients talking about the signals we see from not just an individual company perspective, but also from a macro perspective.
Those type of questions have become even more frequent in the past week, so we're sure many Altimetry Daily Authority readers are having the same thoughts. It's hard not to react when the financial carnival barkers are shouting at you every moment you're tuned into CNBC on TV.
As regular readers know, we have a systematic approach to macro analysis here at Altimetry. We don't just react to the headlines... unlike most pundits and (unfortunately) investors.
Instead, we start at a base of our Uniform Accounting and credit-cycle work. We build up from research we've done on centuries of economic cycles to understand where we are in the market cycle, and what it means for the broader environment.
If you follow a systematic approach likes this, it takes away the guessing game.
Coming into mid-late January and after the rally in February, we were at a point with extended investor sentiment levels and fewer incremental buyers. We could see this in our correlation analysis and our other short-term sentiment indicators.
When this occurs, it signals that investors aren't focused on risk, but rather on upside potential. Any negative news could cause a short-term reversal, as investors panic and run to the exits. And that's what we've seen over the past few days... on Monday, the S&P 500 Index fell more than 3% as investors were spooked over a rising number of coronavirus cases across the globe.
But is a sell-off like that a harbinger for the future of the market... or a buying opportunity? Of course the coronavirus outbreak will have an impact on Chinese and global economic growth for the first quarter of this year and likely the second quarter as well. But this is far more likely to be a transient issue rather than a structural impact on economic growth.
And more important than our opinion about the headlines is to step back and look at the overall macro environment. Let's consider credit cycles and corporate profitability cycles...
Today, credit cycles in the U.S. aren't flashing any warning signs:
- When we look at corporate credit maturities, no significant debt maturities are coming due in the next year that could create a cash crunch.
- Corporate and consumer financial statements remain incredibly healthy in the context of how much income is used to service interest expense and other debt-servicing obligations, and when looking at liquidity reserves.
- Interest rates remain low, meaning that it's inexpensive for companies and individuals to refinance their debts. Just as important, access to credit is still relatively easy to get. And thanks to low default rates, banks are unlikely to start aggressively tightening access to credit.
These metrics don't point to an imminent risk of a credit crunch for either U.S. corporations or individuals. Without a credit crunch, we don't historically see a deep recession or a severe bear market... as one typically leads to the other.
And other key indicators for corporate earnings trends show positive signals...
- U.S. corporate profitability is at sustainably high levels. Structural changes in how companies operate in a more asset-lite, intellectual-property driven, service-economy model mean sustainably higher earning power... and this supports higher valuations.
- Corporations are just starting to spend money on maintenance to replenish old assets after previously avoiding this kind of spending since 2014. With the recent increase in capital expenditures ("capex"), we see real catalysts for structural growth as the trickle-down effect of maintenance capex leads to spending throughout value chains.
- Corporate management teams are showing increasing confidence in investing and overall growth despite the coronavirus outbreak. As management teams become more willing to invest, this historically has led to earnings growth.
- But at the same time, we don't appear to be near the point where euphoria causes value-destructive mergers and acquisitions (M&A) and investment.
Also, as we again touched all-time highs in February before this recent pullback, concerns arose over whether the market was getting too expensive. But when we look at market valuations in the context of the current inflation and tax environments, these look reasonable.
When the market is down 3% in a day – and down almost 5% from its highs only a handful of days beforehand – it's easy to ask whether it's time to head for the exits. Only by having a systematic approach can you stay confident in this type of market environment. This approach is what we aim to give you here at Altimetry, and what we plan on continuing to provide.
The signals from our approach tell us two things... Stay confident in the market, and buy the dips when they occur.
Could the market still go lower from here? Certainly. As legendary value investor Ben Graham said, "in the short run, the market is a voting machine." In this sense, the market behaves like a popularity contest in the short term. Stock prices change quickly based on the current sentiment and environment.
But averaging down into a down market lets you buy stocks you already like at a discount. Over the long term, Graham says that the market is a "weighing machine." The fundamentals will come through... which will drive this market higher.
In short, this is a "buy the dips" type of situation.
And it's worth noting that we aren't the only ones discussing these facts...
Our friend Steve Sjuggerud at Stansberry Research has been highlighting this same dynamic for years with his "Melt Up" thesis. In short, Steve believes this market has much more room to run... and you don't want to miss out on the biggest gains before the inevitable crash.
We have a lot of respect for Steve. When he makes big calls like this, we listen... and although his research process is different from ours, we often come to the same conclusions about the bigger market picture.
He recently sat down to discuss his thoughts on the Melt Up and what he thinks investors should be doing to take advantage right now. You can watch his interview – and find out how to get a massive discount on a subscription to his flagship True Wealth newsletter – right here.
February 26, 2020