Broker Check

Data-Driven Faith Beats Fear; A Changing China Outlook

| August 02, 2021

Big selloffs often act as reset buttons for the market. Our readers know how the trusty Big Money Index (BMI) from MAPSignals tracks institutional investor activity – they also know the BMI fell hard.

However, current data provide evidence that the market is beginning to turn, or at least become range-bound. It’s becoming apparent the BMI should lift soon. Remember, we’re in earnings season and the reports thus far have been spectacular.

Last week we noted how we’d be on the lookout for signs of buying, and as of a couple Mondays ago, we are seeing buyers step in to purchase high-quality stocks. In the below chart, you can see that we're still showing a lot of sell data. However, that's because the recent buying hasn't caught up to the macro data yet:

The selloff a couple Mondays ago now appears to have been a quick flush out. Since then, we’ve seen lots of healthy buying, which should begin to show in the BMI data soon. Still, it’s clearly there under the surface.

That said, we want to address risk. Recent volatility has brought risk to the forefront of investors’ minds, based on many of the conversations we've had. Some are fearful of it, while others wish it didn’t exist.

But in truth, we can never rid ourselves of all risk – in the markets or otherwise. And nowadays, while fear serves a purpose (like in survival situations), when it comes to investing, fear is usually more harmful than good.

In frenzied bull markets, everyone is happy. Stocks in 401(k) plans rise gradually, and it's worry free. But as we've seen recently, volatility does come around.

Say a stock you own that rose by $1 yesterday suddenly drops by $5 today. On day one, you think it will bounce back. On day two, after it doesn’t bounce back, you get a bit uncomfortable. By day three, when the losses continue, your nerves rattle and stopping the bleeding by selling becomes a serious consideration.

This is where fear doesn't help as an investor.

Obviously, no one likes losing money. But all stocks go up and down. It's the down part where emotion takes over and where the biggest investing mistakes are made.

Our philosophy is investors should flip-flop that fear. We should be worried when everything goes up and confident when everything goes down. Warren Buffett knew this when he said, “Be fearful when others are greedy and greedy when others are fearful.”

When everyone's drowning in sorrow, saying they were just set back 10 years, investors’ greed should kick in. Think about the folks who bought aggressively in March 2020 when everything seemed to be tanking. Those people are certainly reaping rewards today.

As we thought about this over the past few weeks, we came to the hypothesis that perhaps the key to investing is merely mastering the mind. Simple task, right? Hardly.

To illustrate this, turning our attention to the BMI, it plummeted the last few weeks and we knew the market would follow suit eventually. The BMI was falling because buyers exited, and sellers seem to have arrived.

The weird part was the indexes were rising while the BMI was falling. It was confusing. But ultimately, things catch up.

We saw small stocks take the punishment first, even while the bigger indexes were rising. We can see that clearly across the four major market indexes:

Looking at the yellow Russell 2000 chart, we can see July's downtrend was present before the other big three felt any pressure. The Dow Jones Industrial Average got hit, but quickly recovered in June. The NASDAQ stayed strong until July 5. The S&P 500 was somewhere in between as that is a blend.

The most important takeaway from this is something that we've been saying for a while – we remain in a washing machine market. Capital continues to rotate, chasing headlines. Fears about rates, inflation, China, the Delta variant, COVID-19 resurging, along with the normal summer volatility, are all contributing to a choppy market.

But what if we looked past the general investment mindset, turning fear of loss into opportunity? Remember, we can truly control only a small amount, and it doesn’t include which way markets go. Admitting that is the first step at managing our attitudes toward risk.

For instance, when the pain comes in great stocks, one way to look at it is being a buyer helps people who are forced to sell. The sellers may be fearful retail investors or professional traders with sell instructions. Regardless, these pressured folks need buyers. If we manage our fear of risk, we can “help them out of a bind” and derive value.

But how do we constantly buy dips? While markets may turn and continue to get ugly in some scenarios, that's unlikely right now. Consider how rates are low until likely 2023 and the economy is booming as earnings roll in.

To exemplify this, according to FactSet, for second quarter earnings so far, with 24% of S&P 500 companies reporting, the following is true:

  1. 88% beat earnings per share estimates
  2. 86% beat sales estimates
  3. The blended earnings growth for the S&P 500 is 74.2%, a high since 2009
  4. Earnings are estimated to grow at 63.2%

Concentrating on this type of strength helps us flip the script and not fear the headline-chasing, short-term volatility.

Market resets can induce fear in investors, specifically fear of risk. Some investors may start to question whether being in equities, with their inherent ups and downs, is right for them. It’s a legitimate question, to be sure.

But it’s also true that stock investors do well when they overcome the fear of risk. A good way to do that is to be as objective as possible, using data to guide decisions. It’s what we do at Cornerstone because it helps distinguish signal from noise. Using data to objectively steer decisions instills level-headed confidence, which is exactly what you want as an investor.

To sum it up, the strength of the current scenario, as evidenced by relevant hard data, gives us faith in the long-term value of high-quality stocks.

China Outlook Changes

While China has certainly grown into an economic force over the last few decades, it is also a tale of regulatory caution for investors, as a recent regulatory crackdown shows. We've seen this increased scrutiny spook investors, sending many of them scrambling for the exits.

For those unaware, the timeline of events began when Bloomberg reported a couple weeks ago that Chinese regulators were planning heavy penalties against ride-hailing giant Didi that could include massive fines and force a delisting in the U.S.

Following that domino, reports emerged of a government crackdown on China's private education sector, which sent those U.S.-listed stocks tumbling. And if that wasn't enough, we then saw China’s “antitrust” regulator order tech giant Tencent to give up its exclusive music licensing rights.

These market concerns then started to seep into the Chinese real estate market. The aggressive regulatory crackdowns in China have led to a common phrase – “You can take the company listing out of China, but you can't take the China risk out of the company.”

These move by Chinese regulators have caused a weeklong Chinese stock crash (tech returns have lingered longer). We bring this up to our readers to let them know we’ve thoroughly evaluated these decisions being made by the Chinese government. We’ve concluded that, as of today, the risks now outweigh the rewards of investing in Chinese companies.

As a result, we made a mid-quarter tactical decision to remove all Chinese exposure from our investment portfolios. Trades were executed last week. Of course, if things change, we will certainly re-evaluate. But as of today, under the current circumstances, we do not feel it is prudent to continue including Chinese investments in our client’s portfolios given this risk adjusted return analysis.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial Services, CoreCap Investments, and CoreCap Advisors are separate and unaf´Čüliated entities.