Economics focuses on the interaction of the supply and demand of goods and services. The finance subject then extrapolates that study over to financial instruments, including stocks. You’d think commodities, with their universal nature, would perhaps be a bit simpler. Oil, for example, would have a greater demand with rising population needs over the years – while technological advances would make it easier to supply. Figure out the difference between the two, and you’re done.
Think again. Did you imagine that crude oil’s price would fall over 50% in the past 2 years? And that Iranian nuclear talks, Yemanese conflict, and storage tank capacity, of all things, would be creating wild swings based on media reports on a daily basis? Trying to predict short term moves for stocks or commodities and capitalizing on them involves a tremendous study of the factors affecting them, and is not worth the risk, in our opinion. The same price declines have led to massive downgrades in earning expectations for the S&P 500 – providing a paltry 0.6% market return so far this year. It’s been a pretty fascinating first quarter, with monetary policy, geopolitics, and other factors impacting stock valuations far more than economic fundamentals. As a result, we recommend sticking with the basics – winning with the markets by staying invested and thinking long term, rather than risking choosing and losing. Here are the two subjects worth highlighting this week:
Taking Over Consumer Goods: Last week’s Kraft buyout announcement was pretty incredible, but not completely unexpected. The Consumer Staples index has outperformed the broader market over the recent past, even though sales for brand titans including Coca Cola, General Mills, Campbell’s, and Kellogg’s have been under pressure given changing consumer tastes and public perception. We attribute the outperformance to takeover premiums factored into their stock prices, knowing that the sharks – buyout funds – have been circling for a while now. Kraft, nevertheless, shot up nearly 40% on the news, a worthy reward for traders that had bet on the outcome. The sector remains one, in our opinion, to stay away from, with prices likely to go down due to sales pressure and a rising interest rate environment later this year – while potential buyout attempts, spin-offs, and management changes would reverse course – as seen with Kraft’s skyrocketing stock last week.
The Search For Yield: As we keep highlighting, fairly valued, saturated markets amid slow global growth have kept investors scouring the world for yield. The biotech sector, as we mentioned last week, remains one of the few fields showing solid growth potential – and as a result, has provided a way-too-rapid stock return in the recent past as investors have clamored in. It’s important to note that the short interest in this sector is now at 11.4%, compared with 6.4% for the average mid-cap stock, according to the WSJ – meaning the smart money is banking on a pullback (in the short term, in our opinion). Alongside, hedge funds, even with recent market underperformance, continue to rake in assets from investors (5% more under management compared to 2014, according to Barron’s), signaling protective moves by the smart money. Europe’s furious run up over the past 3 months, potential rough seas ahead in the high yield junk bond market (given that the energy sector accounts for 17% of it, according to Goldman Sachs) if oil prices remain low and interest rates go up, and a price-to-sales ratio for the S&P 500 median stock that is at its highest level since 1964 (according to the WSJ and Ned Davis Research) all point to a breather in market returns, along with sustained volatility, in the coming weeks. So, our advice is to keep expectations low, buy on the dips, and think long term.
What it means for you: Given the outlook ahead, we decided to step back from the usual themes we highlight each week, and think about the approach to investing. It’s worth mentioning one of the smartest theories around – the efficient market hypothesis – which suggests that stock prices factor in all the available information in developed markets, and are the best indicator for the value of a company. Simply put, individuals really can’t ‘beat’ the market, or project out future returns with greater accuracy using the same information that everyone else has (unless they’re an insider). Meanwhile, another train of thought, outlined through behavioral finance, suggests that psychological biases influence trader behavior – and as a result, mispricings occur in stocks which investors can take advantage of to outperform their peers, with some winning, and some losing. With both opposing theories having received Nobel prizes, the markets continue to represent the fascinating way in which humans think, interact, and make decisions – and how to approach them remains a contested debate. It’s recommended to talk through the two theories during dinner table conversations, rather than the far more common ‘which stock to buy’ discussions that we tend to get caught up in. Stay invested, think long term, and win with the markets by taking a moment to think on Wall Street.
