There is an old saying that you could give the average investor tomorrow’s newspaper and they still couldn’t make money. Well, if someone had a time machine and made me privy to the below chart two years ago, I have to admit that I think I would have lost a little money up to this point. The chart depicts the expected next twelve months earnings trend (blue line) of the large cap info tech sector and the yellow line depicts the rate of change. What the yellow line tells us is that two years ago, Wall Street sell-side analysts were expecting nearly 40% tech sector earnings growth and now they are expecting earnings to decline by 7%. Over that time, these stocks were roughly flat to down 5%. I find that astonishing.

Bottoms-up stock analysts whether in the investment banks, hedge funds or active mutual funds spend their days speaking to management teams and poring over company financials trying to find a variant view of future earnings. That’s it, nothing else. I spent much of my career doing just that: trying to identify companies where the street thought they would grow earnings by X%, but my work suggested that the correct number might be well above or below that. The key assumption is that if you buy a stock that you think will grow earnings by 20% when consensus only sees 10% growth, you should make at least 10%. You might assume more than 10% because companies that are growing faster enjoy higher multiples than companies that are growing more slowly.

The legendary investor Michael Steinhardt was famous for asking his analysts the same three questions every time when they approached him with a long or short stock idea. He would ask: What is the consensus earnings forecast? What is your variant perception of the earnings outlook? What is the catalyst that will make consensus accept your view? Suffice to say that if you had an idea where the current consensus view of the stock’s future was 40% growth, but that in two-years time the outlook would decay to negative growth, Mr. Steinhardt would have been calling his prime brokers to get a borrow on a new short position.

So, why has the tech sector recovered so much when earnings continue to weaken at an accelerating rate of change? Why has the S&P been so resilient in 2023 led by only a handful of mega-cap tech names all of whom are now dealing with far slower growth than what they had enjoyed? These companies should all be in what Vadim Zlotnikov, Head of Fidelity Institutional, refers to as “growth purgatory”, which is the long and painful multiple re-rating period that has historically occurred when growth stocks lose their respective mojo and make the transition to just ordinary growers. The answer is that, while earnings growth is a key factor, it is only one factor that determines how a stock or a basket of stocks trade. There are of course all the exogenous factors having nothing to do with company performance such as central bank activity, fund flows, market narratives, etc. Benjamin Graham once said, “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.” As of now, the market is voting that we must be pretty close to a bottoming in economic growth and therefore, investors are looking through the “earnings trough” and betting on a re-acceleration of earnings in the future. If that view is wrong, the market will weigh these names at a value that is commensurate to their new reality.

Undoubtedly, the Fed is almost done in what has been the fastest pace of tightening in four decades. Futures markets are pricing in the Fed cutting rates in the latter half of this year. Investors have been conditioned like Pavlov’s dog to anticipate central bank liquidity to fuel the next run up in stocks. Our view is that this is rear-view window investing. We believe that after four decades of falling inflation, the days of riskless monetary accommodation are over. That is not to say that inflation wont continue to fall as we slide inexorably into recession, but that the risk of inflation accelerating is now always potentially right around the corner. Therefore, when Chairman Powell and other Fed Governors tell us they intend to keep rates higher for longer, we believe them. Equities at the current level are pricing in the good ole free money Fed to come back anytime now. We view that as hope, and hope isn’t a sound risk management process.

WealthVest makes no representation or warranty, expressed or implied, with respect to the accuracy, reasonableness, or completeness of any of the statements made in this material, including, but not limited to, statements obtained from third parties. Opinions, estimates and projections constitute the current judgment of Tim as of the date indicated. They do not necessarily reflect the views and opinions of WealthVest and are subject to change at any time without notice. WealthVest does not have any responsibility to update this material to account for such changes. There can be no assurance that any trends discussed during this material will continue.

Statements made in this material are not intended to provide, and should not be relied upon for, accounting, legal or tax advice and do not constitute an investment recommendation or investment advice. Investors should make an independent investigation of the information discussed in this material, including consulting their tax, legal, accounting or other advisors about such information. WealthVest does not act for you and is not responsible for providing you with the protections afforded to its clients. This material does not constitute an offer to sell, or the solicitation of an offer to buy, any security, product or service, including interest in any investment product or fund or account managed or advised by WealthVest.

Certain statements made in this material may be “forward-looking” in nature. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking information. As such, undue reliance should not be placed on such statements. Forward-looking statements may be identified by the use of terminology including, but not limited to, “may”, “will”, “should”, “expect”, “anticipate”, “target”, “project”, “estimate”, “intend”, “continue” or “believe” or the negatives thereof or other variations thereon or comparable terminology.

The S&P 500® is a trademark of Standard & Poor’s Financial Services, LLC and its affiliates and for certain fixed index annuity contracts is licensed for use by the insurance company producer, and the related products are not sponsored, endorsed, sold or promoted by S&P Dow Jones Indices LLC or their affiliates, none of which make any representation regarding the advisability of purchasing such a product. WealthVest is not affiliated with, nor does it have a direct business relationship with Standard & Poors Financial Services, LLC.