Investing is an exercise in calculus. It is by definition multivariate. On any given day there are approximately 25,000 different "signals" emanating from Mr. Market. What I have been trying to do for the last decade in Real Money is to alert you to the ones that matter. There really are only two crucial signals for equity investing. Earnings and interest rates. That's it.
So, today, we saw the beginning of earnings season with a resounding bang from the always reliable Jamie Dimon and JPMorgan Chase (JPM) . But those who bloviate on FinTV about...whatever they talk about...I pay them no mind...constantly miss the forest for the trees. Most companies beat quarterly earnings expectations, that ratio hovers around 70% in most quarters, but it is the comprehensive data that shows the true direction of the economy.
According to FacSet's market commentator, John Butters, S&P 500 EPS are now forecast to fall 6.5% year-on-year for 1Q23. Yes, that figure has declined slightly in the past week (it was 6.9% last week,) but, again, there is no sugarcoating the fact that Corporate America's profits are shrinking.
With 4Q22 EPS having fallen 4.6% for the S&P 500 and with, crucially, 2Q23 EPS forecast to decline 4.6% again, we are smack dab in the middle of an earnings recession. Three quarters in a row is a trend, not an anomaly. So, if the market is rising while earnings estimates are falling, by definition the market is willing to pay a higher P/E multiple.
Why? Well the main factor in any sort of discounting model (like the Capital Asset Pricing Model, CAPM) is the discount rate, which is a factor of market interest rates. But if we look at the CME's FedWatch tool, we see that today the bond market is factoring in an 80% chance of a 25- basis-point rate hike from the FOMC at their next meeting on May 3rd.
In the short-term, money is going to cost more, and that should make stocks less valuable, not more. The secret to this market's bullishness is likely contained in longer-term interest rates, not shorter-term ones. The yield on the 10-year US Treasury note today sits at 3.52%. So, while Powell and his feckless cronies at the FOMC finally cue to the fact that inflation is not transitory, the bond market is telling us that...it is? Really?
The 10-year UST yield ended 2022 at a level of 3.88%, so while Powell and the FOMC have raised short rates by 50 basis points this year, the bond market has cut long-term rates by 35 basis points. Who is right? Well, honestly, I don't care.
At my firm, Excelsior Capital Partners, we are heavily invested in fixed-income securities with several arrows in our quiver. As I am concerned about a rebound in longer-term rates, I created a model portfolio called WYLD, which is entirely composed of floating-rate preferreds. I have noted one WYLD constituent, Valley National Bancorp (VLYPO) , currently-floating-rate perpetual preferreds issued by VLYPO, in prior Real Money columns, and I bought some more VLYPO for client accounts this week.
If interest rates don't spring back, or even decline further, then fixed-rate preferreds like those in my BIG SIX model portfolio will be suitable investments. I like the monthly-pay fixed-rate preferreds issued by Gladstone Commercial ( (GOODO) and (GOODN) ) and Gladstone Land ( (LANDO) and (LANDM) ) and have also been buying those securities for client accounts this week.
I looked at a reference account held at Wells Fargo (it's a personal account of mine) and was happy to see the little asset allocation pie chart showing 95% fixed income. Yeah, baby! Actually the 5% that Wells classifies as common equity is a limited partnership ( (KNOP) , issued by KNOT Offshore Partners) so technically my pie chart should have no slices. 100% fixed-income.
That is how I roll, and I am loving the unleashed power of compounding that comes from reinvesting my monthly dividend and interest payments into...the same securities.
It is how wealth is built. In an earnings recession, with a belatedly activist Fed -- they are raising rates now to put out an inflation fire they started with the historically unprecedented growth of the Fed balance sheet during 2020 and 2021 -- it is also how wealth is protected. I'll take that calculus.