today’s discounting mechanism


Discounting is Wall Street jargon for new information being factored into stock prices.

Discounting isn’t a single thing.  In the 1920s, for instance, company managements issued unreliable financial statements while happily passing along inside information to their bankers.  Ordinary investors fended for themselves with the only tool they had back then–watching prices and stock charts.

When I entered the stock market in late 1978 there were already laws requiring publicly traded companies to file detailed financial statements with the SEC.  From the early 1970s cadres of well-paid analysts poring over them and creating the microeconomics of firm and industry behavior.  Yes, there were still throwbacks who expected analysts to be part of their public relations efforts…and there was pressure on analysts who worked for brokerage houses to make their ideas known to the proprietary trading  desk before anyone else.  Still, the playing field was a lot more level.  There were significant rewards for original research conclusions, particularly with traditional growth companies, where the game was, and still is, finding situation where the consensus was too pessimistic about the rate of profit growth and/or the length of time unusually high earnings gains could be sustained.  Typically, stocks would start to rise a year or more in advance of confirming earnings.  In over-bullish markets investors might discount as much a three years into the future; in the depths of bear markets investors would stick to actual earnings and not discount the future at all.

In the 1990s this dynamic began to change, as investment managers began to lay off their in-house analysts on the idea that relying on brokerage research was a lot cheaper and a lot less effort.  In 2000, the SEC passed Regulation FD, which required publicly-traded companies not to make selective disclosure of corporate information (the presumed recipients were investment bankers and institutional shareholders).  Replying to an analyst’s novel question or inadvertently revealing information through body language became worrisome enough that companies either stopped having meetings or developed canned presentations and pretended they were news.  In the wake of the financial crisis, brokers laid off virtually all their experienced analysts.  Since academics are totally clueless about finance, this left no place for newcomers to learn how to do traditional analysis.

Enter AI–whose specialty is reacting to newly released information with lightning speed rather than anticipation of yet-to-be-announced developments.

What is a fundamental analyst to do?

Strategically, fundamentals-based investing remains the same, I think–figuring out potentially market-moving information before the average market participant does.  Today’s tactics are different, though.  Fifteen years ago, the best strategy would have been to amass a large position in a given stock and wait for the market to work out what you already knew.  Price action would tell you when/if that was happening.  There would likely be bumps in the road, but these would offer opportunities to add.

I think the better course of action now is to start with a smaller position and use AI-induced volatility to add and subtract.






thinking about 2020

where we are

The S&P 500 is trading at around 25x current earnings, up from a PE of 20x a year ago.  Multiple expansion, not earnings growth, is the key factor behind the S&P rise last year.In fact, earnings per share growth, now at about +10%/year, has been decelerating since the one-time boost from the domestic corporate income tax cut cycled through income statements in 2018.  Typically earnings deceleration is a red flag.  Not so in 2019.

EPS growth in 2020 will probably be around +10% again.

About half the earnings of the S&P come from the US, a quarter from Europe and the rest from emerging economies.  The US will likely be the weakest of the three areas this year, as ongoing tariff wars take a further toll on agriculture and manufacturing, as population growth continues to wane given the administration’s hostility toward foreigners, and as multinationals continue to shift operations elsewhere to escape these policies.  On the other hand, Europe ex the UK should perk up a bit, emerging markets arguably can’t get much worse, and multinationals will likely invest more abroad.


interest rates:  the biggest question 

What motivated investors to bid up the S&P by 30% last year despite pedestrian eps growth and Washington dysfunction?

Investors don’t buy stocks in a vacuum.  We’re constantly comparing stocks with bonds and cash as alternative liquid investments.  And in 2019 bonds and cash were distinctly unattractive.   The yield on cash is close to zero here (elsewhere in the world bank depositors have been charged for holding cash).  The 10-year Treasury started 2019 yielding 2.66%.  The yield dipped to 1.52% during the summer and has risen to 1.92% now.  In contrast, the earnings yield (1/PE, the academic point of comparison of stocks vs. bonds)) on the S&P was 5% last January and is 4% now.

The dividend yield on the S&P is now about 1.9%.  That’s higher than the 10-year yield, a situation that has occurred in our lifetimes only after a bear market has crushed stock valuations.  In my working career, this has happened mostly outside the US and has always been a clear buy signal for stocks.  Not now, though–in my view–unless we’re willing to believe that the current situation is permanent.

The situation is even stranger outside the US, where the yield on many government bonds is actually negative.

In short, wild distortions in sovereign bond markets, a product of unconventional central bank measures aimed at rescuing the world economy after the 2008-09 collapse, have migrated into stocks.

How long will this situation last and how will it unwind?


more on Monday