Broker Check

The Required “Positivity Premium” and How to Navigate Rising Rates

| May 02, 2022
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Earnings are being released for publicly traded companies and we’re seeing an interesting phenomenon unfold. That is, for stocks to rise, they need a “positivity premium” in addition to top-notch performance. Let me explain.

It’s becoming clear that it isn’t enough for companies to earn more revenue than expected (a so-called top-line beat). Nor is it enough for those same companies to also earn more profit than expected (a bottom-line beat). Stocks of companies with top-line and bottom-line growth have still dropped recently.

In today’s market, for a stock to pop, it needs revenue and earnings beats along with a third crucial ingredient – an increase in forward-looking projections compared to analyst expectations.

This was evident last week in three stocks we own in our client portfolios* – PepsiCo, Inc. (PEP), QUALCOMM Incorporated (QCOM), and Archer-Daniels-Midland Company (ADM). All three had top- and bottom-line beats as well as guidance for the rest of the year that was significantly higher than analysts expected.

We’ve seen some other stocks beat quarter expectations but keep forward guidance the same and they’ve suffered in afterhours trading, despite the excellent business performance. Unfortunately, sales and profit growth simply aren’t enough right now.

The winners in this market are profitable and have strong cash flows that are growing. The name of the game is guidance that points to growth. Absent a bright outlook, investors seemingly think companies are at risk of decline. And the ones that actually decline are getting hammered hard – there are severe penalties for underperformance right now.

This helps explain the market drops recently.

Our friends at MAPsignals track “big money” investor activity that moves markets. Their excellent work has indicated another reason for the recent market drop – buyers are gone. There seems to be a waiting game happening as defensive sectors like energy and materials continue to shine.

Defensive sectors are the reason MAPsignals’ trusty Big Money Index (BMI) didn’t fall more over the past few months. But now the buyers are gone, even from the bullish sectors. And with help of MAPsignals data, we’re able to tackle things head on and improve our understanding.  

From a macro perspective, defensive sectors have been pushing the BMI to its highest level since November. But without buyers, the BMI has nosedived from a recent high of 71% down to 54% on April 27:

While we expect some choppiness, up until last week we’ve been “lucky enough” to see some rangebound action due to rotations under the surface. But the recent lack of leadership anywhere has led to “big money” buyers disappearing, hence the current fall.

The following two charts show how there’s been practically no buying in stocks or exchange-traded funds (ETFs) since April 21:

Last Tuesday alone, MAPsignals data showed 209 stocks being sold with zero buys. That should make the BMI fall more. But please understand, this isn’t meant to scare anyone. Keep in mind, markets like this don’t last forever.

In fact, days with zero buys can actually be the starting point of great bull runs.

MAPsignals again did the heavy lifting to show how markets performed after big selling and no buying. They first looked back at days when the Invesco QQQ Trust (QQQ), a common proxy for the NASDAQ market, was down more than 3.5%. Going back to 2003 there were 59 instances, and as this table of average returns shows, the bulls ran afterwards:

Secondarily, MAPsignals looked at all the days since 2003 when “big money” sold at least 200 stocks and bought less than 10. These are the “deep red” days. There were 113 days similar to last Tuesday, and the forward performance again is extremely positive:

While the short-term outlook for stocks right now is cloudy, the studies above provide some comfort and confidence going forward that these big selloffs are great opportunities to add high-quality assets. For instance, subpar companies do not make it into the QQQ.

Be Where the Tides Are

The market has sent a clear message recently – questionable growth companies will be crushed. But if you drill down and know where to rotate capital, as we have with our model portfolios the entire year, there are positive safe haven returns to be had.

Right now, there's little room for stocks exposed to anything other than the sectors the market trusts. This theme has become even more pronounced over the last 10 days or so due to the increasingly hawkish Federal Reserve rhetoric about how wrong it got inflation. Fed Chairman Jerome Powell even telegraphed an upcoming 50 basis point rate increase.

But the bond market already knew the jump was a done deal and we’re seeing the market price in the notion that there may be a 75 basis point hike followed by additional mega hikes in June and July. As you can see in the below chart from FedWatch, there’s a 99.6% probability of a 0.75 point hike coming this week:

The Fed meets eight times per year. But the bond market votes every trading day.

Our key takeaway remains the same. We’ve said it for a while – avoid bonds in favor of quality stocks that pay growing dividends. Just look at the below chart and the damage being inflicted in the investment grade corporate bond market. Interest rate shock is hitting assets everywhere:

Bond investors are getting crushed. CNBC even reported last week that there is roughly $55 trillion invested in the U.S. bond market and $5 trillion of that has been eliminated in the past two weeks alone.

This action reinforces our 2022 asset allocation. We’ll continue to stay with what has been working, and that is the six most favored sectors: energy, consumer staples, utilities, real estate, agricultural business, and health care.

Remember that what matters is where sovereign, endowment, pension, and institutional money is flowing (i.e., big money). These are the tide makers.

Investors want to be riding the waves when the big tides come in, and it doesn’t take a ton of cleverness to make that happen. Don’t try to outsmart the market. Instead, be in the places the market wants to own (they’re listed above).

This is the thesis we’ve been championing since the second half of last year, and we’ll stick with what works until it doesn’t.

*Cornerstone Financial Services, LLC owns PEP, QCOM, and ADM directly in managed accounts and may indirectly through ETF investments for clients.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC.  Cornerstone Financial and CoreCap are separate and unaffiliated entities.

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