Look to the ignored areas of the market for returns: Portfolio manager
With less than two weeks to go before the U.S. presidential election, expect markets to be extra sensitive to the political circus. News relating to COVID-19 stimulus or health care could turn them on a dime.
For day traders, opportunities and pitfalls will open and close with the swirling uncertainty. For long-term investors saving for retirement, it’s just noise. What really matters are the latest batch of corporate earnings.
Despite the bluster over which party is best for the economy, history shows politics has little long-term impact on the economy, overall corporate earnings, and the stock market. For proof, take a look at a long-term chart of the benchmark S&P 500 or TSX Composite and try to correlate political events.
Trying to time investments based on politics is a huge gamble. Take coal, for example. Donald Trump won the presidency in part by promising to revive the coal industry. From January 2017 – the year he took office – to January 1, 2018, the VanEck Vectors Coal ETF increased in value by nearly 40 per cent. Since then, the price of coal has plunged 57 per cent.
The point is, political will and bullying can’t make the world want coal. Low demand leads to low prices; low prices lead to low revenues; and low revenue lead to low earnings.
All governments can really do is implement policies to encourage sustained economic growth or limit economic devastation. Even when trying to gauge how COVID is impacting the economy, the best place to start is at the ground level, front-line trenches where corporations fight it out for earnings.
Value investors call it a bottom-up approach. Value investing is popular with long term investors because the value style seeks stocks that have not yet realized a company’s long-term earnings growth potential — and that could take time. The price of a stock at any given time is a reflection of what markets believe is a company’s ability to grow earnings. If the price of a stock is below its earnings potential a value investor will buy it. If the price is above what the company is capable of earning, the value investor will sell.
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The relationship between a company’s earnings potential and its current price is reflected in the price-to-earnings ratio (PE). Determining a company’s earnings potential isn’t easy and might better be left to a qualified investment advisor – especially with the latest quarterly earnings reports.
Just over one-quarter of the companies listed on the benchmark S&P 500 have reported third-quarter earnings so far. According to New York-based earnings tracker Refinitiv, results from those companies, blended with estimates from those yet to report, point to a jaw-dropping 17 per-cent plunge in earnings compared with the third quarter of last year. A value investor would assume those results and estimates are already priced into the market, but Refinitiv also reports 84 per cent of the companies that have reported beat estimates. Historically, since 1994, only 65 per cent of the S&P 500 beat expectations. To put it another way, corporate earnings so far are 17.4 per cent above expectations compared with a 3.5 per cent historic average.
Only a few TSX-listed companies have reported third quarter earnings so far, but Refintiv reports the rate of companies beating is already 74 per cent compared with 52 per cent average over the previous four quarters.
That means the market has underestimated corporate earnings, and opportunities for bargain hunters are out there.
How well your portfolio reflects the S&P 500 and TSX Composite depends on how well diversified it is. If the holdings are the best companies in each sector and geographic region, you might be able to mute earnings season as well.
Payback Time is a weekly column by personal finance columnist Dale Jackson about how to prepare your finances for retirement. Have a question you want answered? Email firstname.lastname@example.org.