Broker Check

Identifying True Value Amid Chaos and Noise

| November 07, 2022

We’ve written in the past how bond markets have been controlling the equities markets. Within this current range-bound trading environment, bonds are the tail that wags the equity dog.

So, it shouldn’t be surprising that with the recent retreat of the 10-year Treasury yield off 4.33% highs, the stock market had a nice rebound:

This has happened in concurrence with earnings that have been not as bad as expected. The better-than-feared earnings allowed markets to rise, even though the 10-year Treasury yield has stayed above the 4% trigger in our capitalized profits model (4% or above in our model enables lower lows for stocks, but earnings have adjusted the model as well to allow for a bigger discount rate).

When it’s up to the bond market to decide what happens to stocks, then the fate of equites is essentially in the hands of Federal Reserve Chair Jerome Powell.  With another 75-basis-point jump in interest rates just announced with an aggressively hawkish tone, along with Powell’s commentary about needing to fight more, stocks reversed and fell as bond yields kept rising.

Even more action may occur as investors continue to adjust to Powell’s commitment to attack the market, just as he did in August. Personally, we wish he would have struck a more measured tone – he’s made too many consecutive mistakes for a central banker, in our opinion.

Chair Powell overstimulated to the upside in 2021 with excessive quantitative easing. He has pressed hard in the opposite direction this year. If he didn’t ease too much in 2021, causing markets and the economy to rise, we wouldn’t have to go through excessive quantitative tightening on markets and the economy this year.

Our desire for a measured tone is because big actions can have long tails. Why haven’t aggressive rate hikes curbed inflation and growth? Things take time. This situation reminds us of how an aircraft carrier takes multiple miles to come to a complete stop after the engines have been turned off.

Based on companies reporting sales and profits so far, the economy appears to have actually held up well in the third quarter as it started to adjust to rising interest rates. The fact that gross domestic product advanced 2.6% after two negative quarters provides us worry that the Fed is likely to remain unnecessarily overly hawkish:

What is Value?

We expect more volatility from the Fed’s announcements this week. But as earnings have continued to come out, we have noticed that buyers are beginning to step through the wreckage to take advantage of undervalued opportunities.

That’s led to a significant bounce in MAPsignals’ trusty Big Money Index (BMI), which measures “big money” investor activity, even in the face of horrible big tech earnings from Amazon (20% drop after earnings), Google (fell 6% after earnings), and Meta (formerly Facebook, 24% decline after earnings):

It’s clear this market is being driven by sectors like energy, industrials, staples, financials, and health care once again (also notice how every sector had more buying than selling):

This brings us to a question – what is true value?

Well, what value is and what it should be are often different. For example, the current macroeconomic environment is pressuring tech stocks and lifting energy equities. Yet, it’s likely our reliance on technology will only increase over time. Theoretically, that would mean it’s valuable.

We think there’s an argument to be made that technology is more valuable than oil long-term. But that doesn’t matter right now. The fact remains that the energy sector has accounted for 18.2% of all “big money” stock buying this year while technology is responsible for 19.1% of all the “big money” selling:

The world may believe that technology and ESG stocks are better for our future. But that doesn't mean they're worth more than oil stocks now. Energy, for example, is still ranked as the top sector in terms of technicals, despite its average fundamentals. Meanwhile, tech is still ranked as the highest sector fundamentally, but near the bottom from a technical standpoint.

Still, you might point out how big tech earnings are horrible. Look at Google, Amazon, and Meta’s announcements. But that would be looking at the market with horse blinders on. Such a narrow focus blinds one to good things happening.

For instance, while big tech was caught flat footed, overall earnings are largely better than expected. As of this writing, 52% of S&P 500 companies have reported earnings so far. Most recently per FactSet, 71% of those firms have beat earnings estimates and 68% have beat revenue estimates (notice tech’s place next to energy):

What’s interested us the most is that while mega tech seemed to crumble from poor earnings reports, the buying that has been going on under the surface is much broader and includes small- and mid-cap stocks:

This is what is driving the current market and the BMI higher. The small- and mid-cap stocks being bought are high quality, with high-ranking fundamentals.

Yes, it’s still early in the earnings cycle, but ample buying of fundamentally strong stocks in weaker sectors shows us that value hunters are among us, even with the Fed carnage. Remember legendary investor Warren Buffett’s famous line, “Price is what you pay. Value is what you get.”

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