Category: Markets

Mismatches Between a Company’s Words and Actions

Posted on by phoffman@channelchek.com

Investors Especially Hate Companies that Say They’re Good Then Behave Badly – Unless the Money is Good

The Big Idea

Stock investors punish companies caught doing something unethical a lot more when these businesses also have a record of portraying themselves as virtuous. This hypocrisy penalty is the main finding of a study we recently published in the Journal of Management.

Companies often espouse their supposed virtue – known as “virtue signaling” – usually with the aim of getting benefits, such as higher sales, positive investor sentiment or better employees. We wanted to know what happens when such companies then do something wrong.

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of, Brian L. Connelly, Professor of Management and Entrepreneurship, Auburn University, Lori Trudell, Assistant Professor of Entrepreneurship, Clemson University.

So we examined corporate communications and media coverage for every company in the Standard & Poor’s 500 to develop a comprehensive database of both virtue signaling and misconduct.

To gauge virtue signaling, we conducted linguistic analysis of each company’s letters to shareholders. This is a form of computer-aided text analysis that identifies and categorizes language to draw inferences. For example, we looked for words and patterns to identify conscientiousness, empathy and integrity and considered how language patterns developed over time. Each company received a score that reflected how much of their corporate communication was devoted to virtue rhetoric.

We then examined over half a million news articles to identify unethical behavior, such as egregious events like a CEO’s being fired for sexual misconduct, but also less severe transgressions, like not treating employees fairly.

Finally, our study considered how shareholders respond. Specifically, we looked at price swings the day after the media initially reported the misbehavior.

We found that share prices fell 1.5% overnight in response to unethical behavior when companies had engaged in lots of virtue signaling, compared with 0.4% for those that did less virtue signaling or none at all. For an average company, that difference amounts to over half a billion dollars in lost value.

Keep in mind, too, that these ethical violations are not uncommon events. About a quarter of companies in our sample engaged in this kind of behavior in any given year. Stated simply, bad things happen, and when they do the stock market will clobber those who do not seem to be walking their talk.

Well, with one critical exception related to a company’s expected future performance. If investors anticipate that a company will perform well in the future, there is no hypocrisy penalty – the consequences of misconduct are the same for those that use virtue signaling and those that do not.

Apparently, shareholders are very concerned about executives who say one thing and do another – unless the company is expected to make lots of money, in which case there is little or no penalty for unethical behavior.

Why it Matters

Many companies, and the CEOs who run them, publicly say they care a lot about their people, the environment and the communities around them, among other virtuous signals.

For example, ice cream maker Ben & Jerry’s proudly declares that it seeks to “advance human rights and dignity, support social and economic justice for historically marginalized communities, and protect and restore the Earth’s natural systems.” At the other end of the political spectrum, restaurant chain Chick-fil-A proclaims that it is “about more than just selling chicken”; its corporate purpose: “To glorify God by being a faithful steward of all that is entrusted to us.”

Whether from the right or the left, this virtue signaling establishes, and implicitly promises adherence to, a set of ethical standards. What happens, though, when behavior does not align with virtuous talk?

Academics have two decidedly different views about how to answer this question. Some contend that virtue signaling buffers companies from the negative ramifications of misconduct. Another perspective suggests that there’s a more severe adverse reaction whenever anyone deviates from expectations. Think, for example, of the special vehemence reserved for the priest who pilfers from the church coffers.

Our study confirms that the latter – a hypocrisy penalty – is more likely what is happening.

What’s Next

We are now exploring different types of shareholders and how they respond to organizational behavior – and misbehavior. For example, social activist funds could be especially put off when companies in which they invest behave badly, whereas the most powerful institutional investors are less likely to be concerned about a mismatch between a company’s words and deeds.

Stock Market Imbalance Has Fastest Increase in 60 Years

Posted on by phoffman@channelchek.com

The Warning Signs that the Mega-Cap Era Is Coming to an End are Growing

By Monday of next week, the Nasdaq 100 will be rebalanced to reduce the weighting of its top holdings and add weight to the smaller companies represented. This event can be grouped with the number of experts and outlets waving yellow and red flags warning U.S. stock market investors about the reliance on mega-caps for continued performance. The number of warnings has been increasing. The original purpose of any index is to measure overall market or sector performance. Currently reported performance in the most popular indexes is dependent on five to ten mega-cap names – this trend is not sustainable through time.  JP Morgan (JPM) is the most recent firm to warn about an extreme concentration of a few stocks.

JPMorgan Chase & Co.’s equity analysts, led by Chief Global Markets Strategist Marko Kolanovic, warn that overweighting towards very few companies of extremely large-cap stocks could spell trouble ahead. In a research note published on July 24, the firm writes historically, such periods of extreme concentration have often led to negative outcomes. In fact, the current level of concentration is growing at the fastest pace since the 1960s, surpassing even the extremes seen during the infamous dot-com bubble in March 2000.

To illustrate the stark divergence between the largest U.S.-listed companies and the rest of the market, the JPM team compared the six-month change in the index weighting of the ten largest stocks in the S&P 500 with that of the next 40. This analysis revealed that over the past six months, the divergence has widened in favor of the biggest companies, reaching levels comparable to the “Nifty 50” era of the 1960s—a period when large-cap stocks were highly favored by investors.

JPM Chase, July 24, 2023

Crowding in growth stocks represented in the S&P 500 is currently at the 97th percentile historically. This is a level not seen since the dot-com bubble period. While the team provided extensive data and analysis to support their concerns about overconcentration, they were less definitive about the timing or specific implications for the market.

JPM Chase, July 24, 2023

A selloff is expected and appears likely according to JPM; predicting its timing is more challenging. The team pointed out several potential catalysts, such as a deep recession or a sudden resurgence of inflationary pressures, but it remains uncertain when the downturn may begin. Nonetheless, the JPM team believes that the peak in concentration will coincide with waning investor interest in the generative AI/large-language model theme, a trend that has contributed this year to the significant divergence in equity performance.

In light of Monday’s special rebalancing of the Nasdaq-100, the JPMorgan team suggested that this move could potentially mitigate concentration risk by easing the outperformance of mega-cap technology stocks, including Apple Inc., Microsoft Corp., Nvidia Corp., and Alphabet Inc., which have been major beneficiaries of the AI boom. If a larger percentage of dollars entering large-cap funds find their way to the ticker symbols below the giants at the top, the pace at which the markets have become unbalanced may slow or correct without a major problem.

The JPM team pointed out that if correct, speculators may capitalize on this by considering that the S&P 500 equal weight may be in a position to outperform the S&P 500 traditional weight methodology products over the next three to six months.

Interestingly, there are already signs that the overconcentration problem highlighted by JPMorgan are beginning to ease. Over the last month, the S&P 500 equal-weighted index has outperformed its market-cap-weighted counterpart by 2 percentage points, according to FactSet data.

Despite these concerns, the U.S. stock market closed higher on Monday, with the Dow Jones Industrial Average booking its 11th consecutive daily gain, marking its longest winning streak in nearly six years. The performance of the value-heavy Dow, which has been catching up, while the year-to-date rally of mega-cap tech stocks has stalled, highlights the ongoing dynamics in the market.

Take Away

While some market gurus like Michael Burry have been warning of a bubble brought about by index funds, since 2019, the weighting in indexes have only increased. By the last day in July, the Nasdaq 100 will have taken steps to relieve some of the pressure by shrinking the weighting of the top holdings. JP Morgan analysts are still concerned that the trend is strong and can end with a catalyst triggering an unwinding and move away from the larger high P/E names.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://insight.factset.com/topic/companies-and-markets?_ga=2.236820420.453682497.1690312070-153117876.1690312070&_gac=1.92287727.1690312086.Cj0KCQjw5f2lBhCkARIsAHeTvlgwKsM2zr6tQTIKuToXNk5q7Ukbankb732U4FD1PQ7yHveCJjDgyA0aAkF9EALw_wcB&_gl=1*3sxwh5*_ga*MTUzMTE3ODc2LjE2OTAzMTIwNzA.*_ga_2Q3PTT96M8*MTY5MDMxMjA3MS4xLjEuMTY5MDMxMjA5MC4wLjAuMA..

https://www.marketwatch.com/story/overconcentration-in-u-s-stock-market-has-reached-highest-level-in-60-years-jpmorgan-warns-6f8a0766?mod=hp_LATEST&adobe_mc=MCMID%3D04828691964107368544310185344499067435%7CMCORGID%3DCB68E4BA55144CAA0A4C98A5%2540AdobeOrg%7CTS%3D1690290760

The Week Ahead –  FOMC Meeting and Earnings Reports Will Shape the Mood

Posted on by phoffman@channelchek.com

This Trading Week May be Pivotal in the Push and Pull Between Bulls and Bears

The overwhelming focus this week is on the FOMC meeting Tuesday and Wednesday. There is widespread expectation that after skipping a chance to raise rates in June, the Federal Reserve will bump the overnight lending rate up by 25 bp. This would push the target to 5.25%-5.50%. Policymakers have been clear that they don’t believe they are finished in their battle against inflation but have always maintained their actions are data-dependent. Data on inflation over the past month indicate previous moves could be having the desired impact. If the FOMC determines inflation is trending toward its goal of 2% and is expected to stay on the path, it may not find another hike prudent. However, the Fed won’t see a June reading on its preferred inflation indicator, the PCE deflator, until after the FOMC meeting.

Monday 7/24

•             8:30 AM ET, The Chicago Fed National Activity Index in June is expected to have risen to just above neutral at 0.03 (zero equals historical average growth). This would be up from a lower-than-expected minus 0.15 in May.

•             9:45 AM ET, The Purchasing Managers Index Composite flash reading has been above 50 in the last five reports with the consensus for July at 54.0 versus June’s 54.4. A reading above (below) 50 signals rising (falling) output versus the previous month and the closer to 100 (zero) the faster output is growing (contracting).

Tuesday 7/25

•             9:00 AM ET, The Federal Open Market Committee meeting to decide the direction of monetary policy begins.

•             1:00 PM ET, Money Supply is forecast to show that M2 for the month of June rose 0.6% to $20,805.5 billion. The markets resumed focusing on money supply as a way to view the progress and impact of quantitative easing. It helps decipher how the Fed’s actions are filtering through the economy.

Wednesday 7/26

•             10:00 AM ET, New Home Sales are expected to slow after a much higher-than-expected 763,000 annualized rate in May. Junes are expected to have slowed to 727,000.

•             10:30 AM ET,  The Energy Information Administration (EIA) provides weekly information on petroleum inventories in the US, whether produced here or abroad. The inventory level impacts prices for petroleum products.

•             2:00 PM ET, The FOMC announcement. After holding steady in June, the Fed is expected to raise its policy rate by 25 basis points to a range of 5.25 to 5.50 percent.

•             2:30 PM ET, The post FOMC Chair Powell press conference helps market participants understand the Fed’s decision(s), if any, during their two-day meeting.

Thursday 7/27

•             8:30 AM ET, Durable Goods Orders are forecast to have risen 0.5 percent in July following June’s 1.8 percent jump. Ex-transportation orders are expected to edge 0.1 percent lower as are core capital goods orders, after also coming in high the previous reporting period.

•             8:30 AM ET, Second-quarter GDP is expected to slow to 1.5 percent annualized growth versus first-quarter growth of 2.0 percent. Personal consumption expenditures, after the first quarter’s burst higher to plus 4.2 percent, are again expected to rise but by only 1.5 percent. Whether or not the US has entered a recession is substantially hinged on whether GDP is negative for a prolonged period (typically two quarters).

•             4:30 AM ET, The Fed’s Balance Sheet is expected to have decreased by $22.371 billion to $8.275 trillion. Market participants and Fed watchers look to this weekly set of numbers to determine, among other things if the Fed is on track with its stated quantitative tightening (QT) plan.

Friday 7/28

•             8:30 AM ET, Jobless Claims Jobless for the week ended July 22 are expected to come in at 235,000 versus 228,000 in the prior week.

•             8:30 AM ET, Wholesale Inventories are expected to increase 0.1 percent (advance report) for June, it was unchanged in May.  

 •            10:00 AM ET, Consumer Sentiment is expected to end July at 72.6, unchanged from July’s mid-month flash and more than 8 points higher from June. Year-ahead inflation expectations are expected to hold at the mid-month’s 3.4 percent which was one tenth higher than June.

What Else

The week ahead is also set to be the busiest one of earnings season. Thursday will be the most intense day. About 30% of the S&P 500 will give their financial updates during the week, including Alphabet, Microsoft and Meta. Several big pharma companies are getting ready to report and it’s a big week for industrial companies and big oil as well.

Sign up for Channelchek updates on this week’s FOMC meeting as announcements unfold, and to be updated on other critical information.

There will be a number of Roadshows held during the week in South Florida and St. Louis. Learn more about who’s presenting and how to attend by clicking here.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/newsevents/calendar.htm

https://us.econoday.com/byweek.asp?cust=us

Why, When, and How to Rebalance Your Portfolio 

Posted on by phoffman@channelchek.com

There are More Reasons to Balance Your Investments than to Let Them Ride

Performance differences of varied allocations in an investment portfolio over time will disrupt the original balance. It doesn’t take long for the portfolio to be overweighted in some sectors and underweighted in others. This can add unintended risk not included in the original plan. One tried and true method of resetting the risk to its original setting, is regular portfolio rebalancing. Below, we’ll highlight why investors rebalance their portfolios, how to know how often is prudent, and the importance of reviewing and maybe revising allocations during the rebalancing process.

Why Do Investors Rebalance Their Portfolios?

Rebalancing helps to retain the characteristics of a decided upon asset allocation. This enforces the mix in sot not veering too far from an allocation that takes into consideration the expected risk adjusted return characteristics of the portfolio, and supports the individuals investment policy statement (IPS)

Asset allocation refers to the distribution of investments across different asset classes, such as stocks, bonds, crypto, real estate and cash. A well thought out portfolio may also consider market capitalization of the securities in the stock portion of their investments as these too have different performance characteristics.

Over time, market movements cause the value of the portfolio assets to fluctuate, as one segment grows faster, or loses value faster than other assets. This unbalances the original asset allocation. Because this is portfolios lose their balance, investors will mark their calendars to, at set intervals, rebalance their portfolios to bring it back in line with the intended allocation.

Bringing a portfolio back to the original decided upon helps with two main important goals.

Risk Management: Different asset classes carry varying levels of risk. By rebalancing, investors can ensure that their portfolios remain aligned with their risk tolerance. For instance, if stocks have performed exceptionally well, their increased value could lead to a higher proportion in the portfolio. Rebalancing allows investors to sell some stocks and allocate the proceeds to other assets to manage risk effectively. Over time this can have the effect of selling off securities as they become overvalued, and buying others when they are undervalued.

Long-Term Strategy: Regular rebalancing forces investors to maintain their long-term investment strategy. It prevents the portfolio from becoming overly skewed towards one asset class, which could result in excessive exposure to specific market conditions. Regularly rebalancing ensures that the investment strategy remains intact, even during periods of market volatility.

How Often Should Investors Rebalance Their Portfolios

The frequency of portfolio rebalancing depends on individual preferences, investment goals, and market conditions. While there’s no one-size-fits-all approach, common rebalancing strategies include:

Time-Based: Investors can rebalance their portfolios on a predetermined schedule, such as quarterly, semi-annually, or annually. This approach ensures regular monitoring and adjustment of the portfolio.

Threshold-Based: Investors can set predetermined thresholds for asset allocation. When the allocation deviates beyond these thresholds, rebalancing is triggered. For example, if the target allocation for large-cap stocks is 30% and it exceed 35%, the entire portfolio would be rebalanced to the original desired mix.

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Reviewing Allocation Changes when Rebalancing

Isn’t selling your winners and increasing your losers a bad strategy? When rebalancing a portfolio, investors should review and carefully consider allocation changes. This is risky because the purpose of rebalancing and doing it at set trigger points is to make sure emotion doesn’t prevent the investor from thinking that a particular allocation will rise, fall, or move sideways forever. If one is reviewing changes to the allocation, they should start with their stated investment objectives and assess the performance and expectations of each asset class against the objectives.

Key points to consider include:

Diversification: Rebalancing presents an opportunity to reassess the diversification of the portfolio. Ensure that investments are spread across multiple sectors, regions, or asset types to mitigate risks associated with concentration.

Investment Objectives: Investors should review whether their investment objectives have changed over time. If so, they may need to adjust their target asset allocation accordingly. If the portfolio is retirement money, as one approaches retirement, conventional wisdom suggests they should reduce assets that expose them to the most uncertain returns.

Market Conditions: Assess the performance and outlook of different market-caps, industries, and overall asset classes. For example, if rates are expected to rise, reducing the weighting in dividend stocks could be a historically-supported wise decision. Allocate resources to areas that demonstrate growth potential while considering expected risk factors.

Take Away

Time-tested wisdom says investors should, at regular intervals or triggers, rebalance their investment portfolio. This helps them take some profits and invest in securities that haven’t yet risen, or perhaps have gotten cheaper.

By rebalancing, investors can manage risk, align their portfolios with their investment goals, and prevent overexposure to assets that have already had their big run and may be ready to retrace their rise. The frequency of rebalancing should be based on individual circumstances and preferences, while careful review and consideration of allocation changes are crucial for optimal portfolio management. Regularly monitoring and adjusting portfolios through rebalancing can help

Paul Hoffman

Managing Editor, Channelchek

The Week Ahead –  With Few Economic Stats, Earnings Reports Will Take on Added Importance

Posted on by phoffman@channelchek.com

The Trading Week is Light on Data and Heavy On Quarterly Earnings Reports

After last week’s lower-than-expected CPI and PPI inflation readings, the markets are far less certain what the FOMC will decide at their policy meeting July 25-26. Clarity is not going to come from addresses by any Fed Presidents as they enter a blackout period where they are forbidden to speak on the subject between July 15 and July 27. One report that the markets will be focused on during the week involves unemployment, which, if up, may cause the markets to rally – remember we are still in a period where bad economic news causes a positive stock market reaction.

Investors looking for direction may find it in the earnings reports as major banks, metals producers, and closely followed tech companies will be releasing their quarterly earnings reports.

Monday 7/17

•             8:30 AM ET, The New York State Manufacturing Index is expected to drop to negative 7 for June after unexpectedly climbing 38 points to +6.6 in May 2023, from a four-month low of -31.8 in May.

Tuesday 7/18

•             8:30 AM ET, The consensus for Retail Sales for June is up 0.4% after unexpectedly rising 0.3% month-over-month in May, following a 0.4% increase in April, which beat forecasts of a 0.1% decline. It’s clear the ability to forecast has been economic numbers, especially consumer activity has been difficult.

•             8:55 AM ET, The Johnson Redbook Index is forecast to show a year-over-year, same week, increase of 1.1%, for the week ending July 15. This would follow a 1.6% increase the prior reading. The Redbook is a sample of large US general merchandise retailers representing about 9,000 stores. By dollar value, the Index represents over 80% of the equivalent ‘official’ retail sales series collected and published by the US Department of Commerce.

•             9:15 AM ET, Industrial Production is expected to have risen by 0.1% in June, after declining by 0.2% from a month earlier in May.

•             9:15 AM ET, Manufacturing Production is expected to be flat month over month for June after rising 0.1% in May.

•             9:15 AM ET, Capacity Utilization is expected to have remained in a non-inflationary low 79.5% rate during June. When industries are bumping up against capacity, costs will increase as operations become less efficient because less effective resources are called on to produce, thus increasing the cost of each unit of production.

•             10:00 AM ET, Federal Reserve Vice Chair for Supervision Michael S. Barr will be speaking on fair lending practices at the National Fair Housing Alliance National Conference. The Fed is in a blackout period this week, so it is expected that there will be no discussion of monetary policy.

Wednesday 7/19

•             8:30 AM ET, Building permits consensus forecast for June is for 1.505 million after May’s strong 1.486 million.

•             8:30 AM ET, Housing Starts month over month for May increased by 21.7%, the forecast is for a decline of 10.2% for June.

•             10:30 AM ET,  The Energy Information Administration (EIA) provides weekly information on petroleum inventories in the US, whether produced here or abroad. The inventory level impacts prices for petroleum products.

Thursday 7/20

•             8:30 AM ET, Initial Jobless Claims are expected to have increased the week ended July 15 to 245,000 from 237,000 the prior week. Employment data ahead of the July 25-26 FOMC meeting, in the absence of any fresh inflation data until the 28th has the potential to move markets.

•             10:00 AM ET, Existing home sales in the US, which include completed transactions of single-family homes, townhomes, condominiums, and co-ops, is expected to decline by 1.2% month over month for June. This would follow a small increase of 0,2% the previous reading.

Friday 7/21

•             No major economic releases scheduled.

What Else

The FOMC meeting is Tuesday and Wednesday during the last full week in July. The Fed can do one of three things, lower rates, raise rates, keep rates unchanged. Like all good multiple choice questions, one of these answers can be eliminated. On Thursday of last week (July 13), Federal Reserve Board Gov. Christopher Waller said he was not swayed by June’s benign consumer inflation data and said he wants the central bank to go ahead with two more 25-basis-point rate hikes this year. “I see two more 25-basis-point hikes in the target range over the four remaining meetings this year as necessary to keep inflation moving toward our target,” Waller said this in an address to The Money Marketeers on NYU, a bond market club with some of the most powerful fixed income professionals as members. If the Fed is data dependent and there is little new data since the last inflation readings, Waller’s position is not likely to change.

Paul Hoffman

Managing Editor, Channelchek

How the US and the UK Intend to Improve Capital Markets

Posted on by phoffman@channelchek.com

Why Issuer-Sponsored Research Has Become a Priority in the UK (and US)

Why are the United Kingdom, The United States, and other countries providing an atmosphere that helps promote company-sponsored research?

Last year the SEC issued a report that was required by Congress on issues affecting the investment research of small companies. Last week the UK accepted, in its entirety, a recommendation on issuer-sponsored research. Both countries recognize the needs of investors, issuers, and the overall economy. Investors and issuers ought to be particularly interested in these changes and how they’ll improve the financial system.

Investment Research

Research is like the grease in the capital markets that keeps money from being stuck. It can be categorized into three types: sell-side research, buy-side research, and independent research.

Sell-side research is provided by full-service broker-dealers for clients to consume.

Buy-side research is created by institutional money managers for in-house use to help them make investment decisions on the money they manage.

Independent research is provided by firms that are neither broker-dealers nor institutional money managers, this service is paid for by investors or at no cost to investors as the company that has issued the security has sponsored the analysis.

Analysts often specialize in a specific industry and will regularly provide research on companies within that industry. This research includes written reports that discuss market developments, financial projections, target prices, and overall ratings or recommendations (such as buy, hold, or sell). The specific content and terminology used in research reports will vary.

These research reports can be published at any time, especially in response to important corporate events like earnings releases. While sell-side and buy-side research may have limited distribution, independent research is more widely available to money management firms and individual investors.

Research helps investors gain clarity about a company and its prospects. It can provide interpretations of significant events related to the company, such as media coverage or predictions from other analysts. Individual investors can also benefit from research reports by using them as part of their overall investment decision-making process.

In addition to producing written research reports, research providers may also assist issuers by arranging meetings or conference calls between investors and the senior management of companies. These roadshows help allow better understanding and communication between investors and the companies they may be interested in.

Overall, research is essential in the capital markets, it provides valuable information and insights that help investors make informed decisions about their investments. It helps reduce uncertainty and allows investors to assess the potential risks and rewards associated with different investment opportunities.

Analysts can also introduce or express their opinions about specific of covered companies using other forums such as video interviews, print media, or investor/issuer conferences. Additionally, sell-side analysts who work for broker-dealers that offer investment banking services may, within regulatory guidelines, be involved in investment banking transactions.

Benefits to Issuer

Research helps investors by discovering and delivering important information about companies. Well-rounded investors consider research an important part of the information they use to make investment decisions, including staying up to date on analyst forecasts for the company and industry, management forecasts, earnings announcements, and SEC filings. This fosters improved liquidity, which benefits price discovery and execution on demand.

According to the Congressionally mandated SEC report titled Staff Report on the Issues Affecting the Provision of and Reliance Upon Investment Research Into Small Issuers, research coverage of a company positively affects the liquidity of its stocks. When a company loses analyst coverage, its stock liquidity can decrease. This decrease in liquidity is more pronounced for smaller companies with fewer analysts covering them. Research coverage also helps investors recognize and pay attention to companies, which affects their value. Investor attention can be gained by engaging research and analysis firms to initiate coverage to gain investor attention.

Excerpt from the Securities and Exchange Committee Report, February 2022, (page 11):

“Studies have shown that research coverage of an issuer is positively related to its stock liquidity and that a reduction in research coverage of an issuer may reduce its stock liquidity. For instance, one study found that issuers that lose analyst coverage for at least one year suffer a ‘significant deterioration in bid-ask spreads, trading volumes, and institutional presence.’

Other studies have found that the reason for this deterioration is that decreases in analyst coverage increases information asymmetry, which can cause issuers to switch to financing that is less sensitive to information asymmetry, including decreasing their use of equity and long-term debt, or cause issuers to decrease their total investment (e.g., capital, research and development and acquisition expenditures) and financing. This decline in liquidity was shown in one study to be more significantly pronounced for smaller issuers, issuers with relatively less analyst coverage, and issuers with a bigger increase in information asymmetry resulting from the loss of an analyst.”

According to the SEC report, research analysts also serve as a comfortable third-party mechanism by monitoring a company’s management. Their scrutiny increases transparency and makes it harder for managers to engage in self-dealing activities. Analysts monitor financial statements, ask questions during earnings announcement conference calls, and distribute information to investors, helping detect any misconduct by management.

When a company loses analyst coverage, according to an SEC review, markets anticipate an increase in agency costs, such as the misuse of cash reserves by managers. The number of analysts covering a company is related to the compensation of chief executive officers and the likelihood of value-destructive corporate acquisitions. Decreased analyst monitoring is also associated with increased earnings management by companies.

The UK Goes All In

On July 10, 2023, the UK formally announced they are on a mission to improve capital markets. A large segment of the new, self-imposed mandate includes the consensus that investment research is an important part of the UK public capital markets and that the availability and quality of expert analyst research is significant in attracting (and retaining) issuers and investors. The Chancellor of the Exchequer is adopting seven action items aimed at “protecting and developing the UK as a centre of excellence for investment research.”

Source: UK Investment Research Review , July 10, 2023 (page 5)

The report states that introducing a research platform to help generate research would help improve research coverage and would help promote a greater interest in smaller cap companies where there is currently a scarcity of research coverage.

The plan is to allow additional optionality for paying for investment research. And would address some of the unintended consequences of the MiFID II unbundling requirements, this aims to increase choices regarding payment for research to permit asset managers to pay for research on a bundled basis and to ensure that UK investment managers remain able to procure research from elsewhere, particularly from the US.

Retail investors have always been at a disadvantage, the UK mission supports greater access to investment research for retail investors, helping to level the playing field.

In developing a research platform open to all, the UK wishes to involve academic institutions and explore situations to strengthen the collaboration between universities and the capital markets ecosystem.  

By providing rules, boundaries, and guidelines, the UK believes it can support issuer-sponsored research by implementing a code of conduct.

The Uk wishes to clarify aspects of the UK regulatory regime for investment analysis or better define it to help simplify access to investment research.

And the last on the UK’s “To Do” list is to review the rules relating to investment research in the context of IPOs with the following points to consider:

  • Changing the FCA Conduct of Business Rules, introduced in 2018, designed to encourage unconnected research analysts to produce research in connection with IPOs. These rules have not had the desired effect of increasing IPO coverage by unconnected analysts but have consequentially extended the UK IPO timetable, putting the UK at a competitive disadvantage.
  • Making IPO-connected analyst research available on a basis similar to the prospectus so that all investors can access the same information.
  • Lower the current restrictions on analysts meeting potential IPO candidates prior to an investment bank being mandated on the IPO are also seen as putting the UK at a disadvantage to other listing venues.

Take Away

Investor access to investment research is important to the capital markets system as it helps money to flow much more easily where needed. Offerings that are better understood and have an additional layer of third-party oversight can attract more needed capital. This reality has been echoed by the SEC and the UK regulatory bodies.

Third-party investment analysis particularly helps smaller companies that may be less understood, as studies show, research coverage improves liquidity among small cap stocks. Investors, particularly retail, benefit from unbiased research and are more likely to make decisions on companies they believe they have a firm understanding of.

All in all, the UK and US authorities understand research provides valuable benefits to investors and the market as a whole. It enhances stock liquidity, increases investor recognition of companies, and serves as an external governance mechanism by monitoring and deterring managerial misconduct.

To have free access to small and microcap company research from the veteran equity analysts at Noble Capital Markets, sign-up here. If you are responsible for the investor relations of a company that may benefit from well-respected coverage, please contact Channelchek here for more information on company-sponsored research.  

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.cfainstitute.org/-/media/documents/code/other-codes-standards/analyst-issuer-guidelines.ashx

https://www.sec.gov/files/staff-report-investment-research-small-issuers.pdf

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1168719/UK_INVESTMENT_RESEARCH_REVIEW_-_RACHEL_KENT_10.7.23.pdf

https://www.lexology.com/library/detail.aspx?g=d36aa9a5-d058-4ddc-93d1-ef430dbe3fe7

Reasons to Be Even More Positive on Small Caps in the Second Half

Posted on by phoffman@channelchek.com

Statistically, 2023 Should Finally Be the Year for Small Caps

It has been six months since I shared the hard data and a graphic from Royce Investment Partners. In the firms most recent letter to investors, the firm reiterated the reality that after any consecutive five-year period where small-cap stocks had returned less than five percent, the following year, returns averaged 14.9%. Senior management of Royce again stated in its July newsletter, that a five-year low-performing period occurred 81 times in history, 81 times small caps had a sixth year with very good returns.

Source: Koyfin

Are Small Cap Stocks on Track to Make it 82 Times in a Row?

The five-year period 12/31/83 through 6/30/23, was below 5% for each year. January kicked off the sixth year return was up over 5%.  Since the strong January, we have had a strong June, and so far July. Year-to-date, the Russell 2000 index is up 9.4%, which is a strong six months – with six months to go. If it stays on course, small caps will keep the “100% of the time history.”

What is even more exciting is that in the month of June alone, the small cap index was up 6.9% and so far in July is up on the month and outperforming large cap indexes, which are all down on the month.   

Source: Koyfin

While a 100% of the time track record is comforting, the idea that so far only months that start with the letter “J” have been up, and after this month, we run out of “J” months, is concerning. The Royce newsletter dated July 7th has pointed out another positive statistic for where we are now.

Co-CIO Francis Gannon recognized, “It’s true that January and June were the only months so far in 2023 when the Russel 2000 had positive returns. There were four straight down months in between.” Gannon explained that this is also a rare occurrence that has occurred only nine times since the start of the Russell 2000 on the last day of 1978. The Co-CIO said, “For the eight periods for which we have data, subsequent one-year returns averaged 24.7%; subsequent three-year returns averaged 21.0%; and subsequent five-year returns averaged 16.8%.”

Source: Royce Capital Partners

These numbers work on a simple, buy-the-dip phenomenom, but quantify it in a way that gives investors confidence that at a minimum there is a rationale behind expanding holdings in small cap stocks.

Take Away

Investing, at it’s core, is putting statistics on your side, expecting that it is not different this time, then letting historical probabilities play out.  Large cap stocks are expensive compared to small caps. This may not be the only reason the two scenarios discussed in newsletters from Royce Capital Partners have played out. But other factors, including a rebalancing of the Nasdaq 100 Index this summer, strongly favor a more competitive performance of small cap stocks in 2023 than we have experienced in five years.

Paul Hoffman

Managing Editor, Channelchek

Sources

Bullish for the Long Run—Royce (royceinvest.com)

Nasdaq Tells Investors, “We’re Taking a Little Off the Top”

Posted on by phoffman@channelchek.com

Nasdaq Special Rebalance Will Create Winners and Losers

The Nasdaq press release didn’t provide much information, but index investors have been talking about the need to reweight large-cap funds for years. Later this month, the Nasdaq 100 will be rebalanced. Unlike the Russell Indexes, which have an annual rebalance process, this will be only the third time in history. The last Nasdaq 100 reweighting was in 2011. This will affect stock prices, potentially, by quite a bit.

The seven big tech stocks like Apple (AAPL), Microsoft (MSFT), and Meta (META) have market caps that rival entire stock exchanges outside of the US. The popular stock indexes, including the Nasdaq 100, weights stocks with a larger market cap more heavily than those with lower market caps. The result is the movement of these indexes don’t necessarily reflect the movement of the stocks within the index. In the case of the Nasdaq 100, ninety-three other stocks taken together are weighted by only 44.5%.

The rebalancing is expected to trim the weighting of at least six of the seven largest stocks in the index and increase the weighting somewhat of many others. Similar to what occurs each June during the Russell Index Reconstitution, index fund managers will have to sell those stocks that experience reduced weight and buy those stocks that have increased weighting in the benchmark index.

The Big Seven that Are Likely to be Trimmed

Microsoft (MSFT)………..12.9%

Apple (AAPL)………..12.5%

NVIDIA (NVDA)……….7.0%

AMAZON (AMZN)……….6.9%

Alphabet (GOOG)……….3.7%

Alphabet (GOOGL)……….3.7%

Tesla (TSLA)……….5.5%

Meta Platforms  (META)……….4.3%

The seven-largest companies in the Nasdaq 100 impact 55.5% of the index’s movement. This combined weighting will be lowered. Investors can also expect relative weighting shifts within these upper echelons.

Current Weighting and Methodology

The Nasdaq 100 index is a modified market-cap-weighted index. Overall Market valuation is the largest factor, but with oversight and review of concentration to help benefit users of the index.

Currently, MSFT has the largest weight. AAPL, which has a larger market cap than MSFT has a lower weight. Alphabet has the next highest weighting with the GOOGL and GOOG share classes combined. NVDA recently jumped to a 7% Nasdaq 100 weight, just ahead of AMZN. Tech/car company TSLA, and META are the final two represented in the top seven that are expected to end the month with some of their current weighting being added to stocks with smaller market values.

Key Dates and New Methodology

The Nasdaq 100 includes the 100 largest non-financial Nasdaq components.

The weighting changes will be announced on Friday, July 14, after the market close. The current 100 tickers will all still be intact. 

The Nasdaq 100 special rebalance will take place before the Nasdaq open on Monday, July 24, to “address overconcentration in the index by redistributing the weights.” This has only happened twice before, in December 1998 and May 2011.

The combined weight of the five companies with the largest market caps, will be set to 38.5. The top four alone, have a combined weight of 46.7%. So these company’s can expect meaningful reductions. Nasdaq has also adjusted its methodology to state that no company outside the top five can have a market cap exceeding 4.4%. This implies that Tesla will also experience a little trim in its weighting.

Why it’s Important

With 17% additional weighting to be shared down the line in the Nasdaq 100 index, there may be a huge shift in individual stocks. The official new weightings are to be released Friday July 14, based on July 3 market data. This will include companies that see an increase in weighing.

According to Nasdaq, more than $300 billion in exchange-traded funds tracked the index as of the end of 2021, that number has since risen considerably. Currently, QQQ, the Invesco Nasdaq 100 ETF (QQQ), by itself, has over $200 billion in assets. Index fund managers using the benchmark will need to sell some of their holdings in the largest constituents of the index, and add to their positions in other stocks, based on the Nasdaq readjustments that we will learn about after the close on Friday July 14.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.nasdaq.com/press-release/the-nasdaq-100-index-special-rebalance-to-be-effective-july-24-2023-2023-07-07

https://www.barrons.com/articles/nasdaq-100-special-rebalance-apple-stock-price-98515240

The Week Ahead –  Beige Book, Inflation Numbers, FOMC Minutes, Employment

Posted on by phoffman@channelchek.com

This Full Trading Week May Decide the Direction of the Markets for the Rest of 2023

Inflation will be a big focus this week as the CPI, PPI, and import and export prices for June will be released in this order at 8:30 on the last three days of the week. These economic reports are the final inflation readings the Federal Reserve will get before its July 25-26 meeting. The Beige Book also has the ability to alter market sentiment as this is a large part of the data and discussions used at the FOMC meeting. The Beige Book, which is information from each Fed reporting district, is released on Wednesday afternoon.

Monday 7/10

•             10:00 AM ET, The second estimate of Wholesale Inventories is a 0.1 percent draw, unchanged from the first estimate.

•             10:00 AM ET, Mary Daley the President of the San Francisco Fed, will be speaking.

•             3:00 PM ET, Consumer Credit is expected to show that consumers borrowed $20 billion more in May. This compares to a $23 billion increase in April.

Tuesday 7/11

•             6:00 AM ET, The National Federation of Independent Business (NFIB) optimism index has been below, and often far below, the historical average of 98 for the past 17 months. June’s consensus is 89.8 versus 89.4 in May.

Wednesday 7/12

•             8:30 AM ET, The Consumer Price Index, or CPI, is expected to show that core prices in June are slowed to a modest 0.3 percent on the month versus May’s 0.4 percent. Overall prices are also expected to rise 0.3 percent. Annual rates are expected to slow sharply at the headline level, to 3.1 from 4.0 percent, and also for the core, to 5.0 from 5.3 percent.

•             10:00 AM ET, The Atlanta Fed Business Inflation Expectations is not one of the more widely watched inflation reports. But in these times of the markets grasping on anything that may foretell where inflation is headed, this number has the potential to be impactful.

•             10:30 AM ET,  The Energy Information Administration (EIA) provides weekly information on petroleum inventories in the US, whether produced here or abroad. The inventory level impacts prices for petroleum products.

•             2:00 PM ET,  The Beige Book is a report on economic conditions used at FOMC meetings. This publication is produced roughly two weeks before the monetary policy meetings of the FOMC.

Thursday 7/13

•             8:30 AM ET, Employment numbers seemed to be the new razor-sharp focus among Fed watchers. Initial claims for the prior week are expected to be at the 248,000 level.

•             8:30 AM ET, Producer prices in June are expected to rise 0.2 percent on the month versus a 0.3 percent fall in May. The annual rate in June is seen at plus 0.4 percent versus May’s plus 1.1 percent. June’s ex-food ex-energy rate is seen at 0.2 percent on the month and 2.8 percent on the year which would exactly match May’s results.

•             4:00 PM ET, Fed’s Balance Sheet data is expected to show that the Fed holds $8.98 trillion in US debt. The total assets are forecast to drop by $42,602 billion.

Friday 7/14

•             10:00 AM ET, the Consumer SentIment first indication for July, is expected to rise to 65.0 from June’s surprisingly high 64.4.

What Else

Last week the BLS reported the US economy added 209,000 jobs in June. This helped cause the unemployment rate to fall to 3.6%, near its 50-year low. This spurred inflation worries and spooked the bond market, which in turn impacted the broader stock market. Looking at the make-up of the numbers may be less worrisome. It seems the US government has been the last to begin hiring after the pandemic. Excluding government hiring, private sector payrolls grew by only 149,000 in June. This is the slowest since December 2019 and below the 166,000 monthly average in 2017-19.

So the reaction may have been more of a reason for the market to take a breather after a strong June, than increased concern over a hot job market.  

Paul Hoffman

Managing Editor, Channelchek

Is the Fed Really Trying to Lower Employment?

Posted on by phoffman@channelchek.com

The Reasons High Employment Concerns the Market

Maximum employment is one of the top mandates of the Federal Reserve, so why is it trying to reduce the number of jobs available? On the surface this would seem backwards. But in economics, everything is related, intentionally slowing growth to the point where resources aren’t stressed, can provide a better balance across the Feds other mandates. These Congressional mandates are stable prices, and moderate long-term interest rates.  

Current Employment Situation

The most recent U.S. Employment Report was released on July 7th. It showed that payroll employment was still climbing during June, and 209,000 new employees were added to company payrolls. The same report showed that the unemployment rate dropped to a historically low 3.6%, and workers earned 4.4% more than a year earlier (In May, it was 4.3% more).

The markets immediately viewed these strong job gains, coupled with an acceleration of wage increases and the drop in unemployment, as foreshadowing a Fed hike in late July. And also viewed is as increasing the probability of additional tightening before year-end. Employment is high, and the labor market is so tight that employers are increasing what they have paid workers in order to attract suitable personnel.

A day earlier, the payroll company ADP released its National Employment Report, which is produced in collaboration with the Stanford Digital Economy Lab. This report also showed a strong labor market. The private sector (non-government) jobs increased by 497,000 in June. This was approximately double the strong number of new hires from the previous month.

Civilian Unemployment Rate

Source: BLS.gov

How More Jobs Translate to Stock Market Concerns

The U.S. Unemployment Rate continues to remain very low despite the Fed’s aggressive efforts to slow the economy and only a modest 2% GDP growth rate. In fact, in April unemployment hit a 50 year low at 3.4% which is just below the June level.

Employment levels in the U.S. are now a key focus of the Federal Reserve (the Fed) in its effort to slow U.S. economic growth to combat persistent inflation well above the Fed’s target. Fed officials have repeated what most market participants know, that achieving lower inflation would be difficult without addressing the increasing prices that employees are receiving for their labor. A strong jobs market pushes wages higher, which filters into higher consumer inflation.

The job market’s continued strength has been somewhat surprising in what appears to be a slowing economy, with consistently low unemployment and solid job growth. This likely reflects unusual dynamics that stem from the novel economy during the pandemic. The economy hasn’t yet balanced out after massive government stimulus, low production, and a changed sense of work among many that are still of working age.

The employment numbers this year show there are still 1.6 job openings for each person that is looking for work. Considering those looking for work and the positions open are largely mismatched, this leaves employers either bidding up what they are willing to pay to attract the right person or producing less than is demanded by the market for their goods or services. Both situations are inflationary.

There are two sides to every problem; while potential employees willing to work represent far fewer workers than there are jobs, there are fewer, of age, adults willing to participate in the labor force. The labor force participation rate now stands at 62.6%, unchanged from the previous four months. Improving labor participation would be a preferred way to address the tightness in the labor market that’s leading to wage inflation, but the Fed doesn’t have the tools to incentivize this. So it is back to raising rates, draining money from the system, and otherwise taking the punchbowl away to end the party.

Good News is Bad News

This is why the Fed is not excited about job growth and low unemployment. And if the Fed isn’t happy, the markets aren’t happy. The bond market selling off in expectation that the Fed is going to raise interest rates lowers bond prices, and the stock market is concerned on many fronts, as high rates increase costs for companies, slow purchases that are typically financed, and with each tick up in rates, bonds and C.D.s become more attractive as an alternative to stocks.

So the good news which is that almost anyone who wants a job can have one, as it turns out, leads to a chain of events that causes concern among those invested in stocks.

But while unfortunate, the Fed actions are long-term good. Inflation quietly erodes the purchasing power of financial assets. So the Fed is focused on what is driving inflation, wage inflation being chief among them.

Take Away

The job market’s continued strength and the wage growth that comes with it creates a perplexing situation for all involved. The Fed has to work to reduce employment pressures, and stock and bond market participants are cheering on bad economic news – this is perplexing for investors of all levels.  

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.bls.gov/news.release/empsit.nr0.htm

https://www.cnn.com/2023/07/06/economy/june-jobs-report-preview/index.html

Five Ways Higher Interest Rates Impact Stocks

Posted on by phoffman@channelchek.com

Interest Rate Increases are Less Frightening When the Impact is Understood

The fixed income market, and the interest rates market in general have a pronounced role in shaping stock market dynamics and equity investor sentiment. At a minimum, higher rates, the cost of money, when increasing, will most directly impact businesses that borrow as part of their normal activity. Other industries find that growing profits is more difficult in a less direct way. And then there are actually sectors that can benefit from an upward-sloping yield curve. Below we cover five different ways that higher interest rates impact stocks, and mention sectors that may be especially hurt, and some that could even thrive if the rates continue to climb higher.

Background

The U.S. central bank, The Federal Reserve has raised overnight interest rates from nearly 0.00% to near 5.25%. Longer-term rates have not followed in lock-step as other dynamics such as future economic expectations, flight to quality, and Fed yield-curve-control have caused longer rates to continue to lag below short-term interest rates.

In recent days there has been some selling in bonds which has driven longer interest rates up. The overall reason is the rekindled belief that the Fed is not finished tightening after the FOMC minutes from June indicated such. But other factors such as investors doing break-even analysis on longer term bonds and then raealizing they may not be getting paid enough interest to offset inflation, or to benefit them more than rolling shorter maturities that may be paying 200bp higher.

The sudden increase in rates, especially the ten-year US Treasury Note which is a benchmark for many lending rates, including mortgages, has caused stock market participants to feel unsettled. Some of their fears may be justified, some may not be.

Five Ways Higher Interest Rates Impact Equities

#1 Higher Rates Impact on Equity Valuations

One of the primary concerns for stock market investors, when interest rates rise, is the potential impact on equity valuations. As interest rates increase, the discount rate used to value future cash flows is then higher. This can put downward pressure on equity valuations, particularly for stocks with high price-to-earnings ratios. Investors become concerned about the potential decline in stock prices and the overall effect on the market’s valuation levels.

#2 Profitability of Interest Rate-Sensitive Sectors

Some sectors are particularly interest rate sensitive. Utilities for example, might have a couple of things working against them. First off, they are notorious for carrying a high level of debt. As this debt needs to be refinanced (as bonds mature), the new bonds need to be issued at higher rates, increasing the utility’s cost of doing business.

Utilities also are popular investments among dividend investors. As yields on bonds increase, there is more competition for income investors to choose from, at times with lower risk, which makes utility stocks less attractive.

As one might imagine REITs, by definition, all have real estate as underlying assets. Rising interest rates can increase borrowing costs for REITs involved in property acquisitions and development. This can potentially affect their profitability and underlying property valuations.

As with utilities, the REIT sector attracts income investors; if bonds become a more attractive alternative, this creates lower demand for REIT investing.

Financial institutions are certainly impacted, however, depending on the segment within financials, some may benefit from increased profit margins, while others are weighed down by increased costs. Basic banking is borrowing short and lending out longer, then managing the risk of maturity mismatch. As longer-term rates rise relative to shorter rates, these institutions find their earnings spread increases.

In recent years the trend has been, especially for larger banks, to create loans and then sell them. They profit on the servicing side, or administrative fees to create the loan. In this way they are shielded from interest rate mismatch risk, and they can make more loans on the same deposit base (selling the loans replenished the funds they can loan from). So the benefit of rising rates on benchmark securities relative to the banks deposit rates could have much less positive impact than it might have if they held the loans. What may actually happen within these institutions is that they experience fewer loans as consumers and business borrow take fewer loans, thus earning less fee income.

#3 Investors Lean Toward Bond Investments

The return on anything is the present value, versus future value, over time held. Higher interest rates can make fixed-income investments more attractive than low rates compared to stocks. When interest rates rise, more investors prefer a known return in terms of interest payments than an unknown move in stocks valuations. This shift in investor preferences can lead to reduced demand for equities and potentially impact stock market performance.

Investors buying bonds as rates are rising will experience a decrease in the value of their fixed income securities. So, they may be surprised to learn that they avoided stocks because stocks may go down in value, and instead invested in fixed income which mathematically will go down in value when rates rise.

#4 Borrowing Costs for Companies

As mentioned earlier, rising interest rates increase the borrowing costs for companies. This can impact corporate profitability and investment decisions, which in turn can affect stock prices. Companies that rely heavily on debt financing may experience higher interest expenses, potentially squeezing profit margins. Investors become concerned about the potential impact on corporate earnings and the overall financial health of companies in a higher interest rate environment.

Analyzing a company’s capital structure, and looking for signs of low debt levels, or long-term debt that is locked in at the low interest rates of the early 2020’s, may be a good way to filter companies that have a profit advantage over their competitors

#5 Consumer Spending and Business Investment

Consumer spending levels are a direct driver in consumer stocks. When borrowing becomes more expensive, consumers may reduce their discretionary spending. This can impact businesses that rely on consumer demand, potentially leading to lower revenues and profitability. The stocks that tend to hold up more when spending levels decrease are those that produce necessities.

Business investment during periods of rising interest rates can influence investment decisions for businesses. As borrowing costs increase, companies may reduce or delay capital investments, expansions, or acquisitions. This cautious approach can impact economic growth and overall industry development, which can in turn affect its performance, for much longer than a quarter or two.

Take Away

Stock market investors have legitimate concerns about the impact of higher interest rates on their investments. The potential effects on equity valuations, profitability of interest rate-sensitive sectors, investor preferences for fixed-income investments, borrowing costs for companies, and consumer spending/business investment are key factors that contribute to investor apprehension. It is as important for investors to monitor interest rate trends and understand the impacts as it is for them to monitor.

Paul Hoffman

Managing Editor, Channelchek

Investment Articles from the First Half, That are Still Well-Worth Understanding

Posted on by phoffman@channelchek.com

The Markets During the First Half of 2023 Were Reflective of the People that Trade Them

Financial markets reflect the collective actions and expectations of market participants. This includes rational analysis, irrational emotions, and at times less than rational analysis. The emotions and number crunching get their cue from a daily barrage of information including: profits, policy, panic, prices, politics, purchasing power, the president …and that’s just the Ps. So each day, as Channelchek prepares to deliver research, articles, and pertinent video content to subscriber’s inboxes, we plow through an abundance of information and hope to share what is either not being addressed or covered, or present front page news from the point of view of seasoned investors, not less experienced news writers.

Below are six articles, one from each month this year. Although I have favorites not included here, and these may not have been the most read or shared, they told a slightly expanded story than found on the mainstream take on the subject and are still relevant to some investors.  

As a content provider to this popular investment research platform, my job is not to call the market; it is to present thoughts and knowledge to help investors make decisions on small and microcap stocks along with the overall universe of investment opportunities. The insights below from earlier this year are still quite current, and worth digesting.  

January 2023

Will Three Bank Regulators Kill Cryptocurrency in 2023?

On the very first business day of 2023, three regulators announced concerns over businesses involved in cryptocurrency citing the lack of oversight, lack of standards, and unknown risk. As the year progressed, the three federal agencies, which do not include work on oversight being done by the SEC or CFTC, are now working hard to regulate what banks can do involving crypto. The SEC for its part has been creating headaches for some of the larger crypto exchanges. Banks are having a particularly difficult time incorporating the asset in their business.

February 2023

Michael Burry Warns Against the Market Hoping for Economic Weakness

Investment content providers love Michael Burry. The reason is that readership goes through the roof whenever his name is mentioned. Still, if there is nothing to write about the subject, or if it is old news, the writer, blogger, or vlogger is doing investors a disservice.

We’re choosy about when to take one of Burry’s rare tweets and decipher them for readers. But, we always try to be among the first when his fund’s public holdings are reported each quarter on SEC form 13-F. But there are only few times during the year when there is actually worthwhile news. This is because Burry is usually tightlipped. Unless required by a regulator, the successful hedge fund manager is out of the public spotlight, presumably crunching numbers and rebuilding old guitars.

This article is good advice that can be used any time the Fed is trying to reel in inflation.

March 2023

The CFA Institute Makes First Major Change to Program Since Inception

It was 1963 the last time the CFA Institute (Chartered Financial Analyst) made any changes to their prestigious designation. However, the investment world is changing, and the CFA Institute is responding in order to better serve those that benefit from the services of skilled analysts. In 2023 CFA candidates will have more choices, more study material available, and the ability to take credit for their rigorous studies beginning after passing Level I.

Some thoughts on why, eligibility, and the new focus are presented here along with how it should help keep the credential fresh and more useful.  

April 2023

U.S. Money Supply, Here’s Why it’s Critical for Inflation Forecasts

It wasn’t too long ago that the Federal Reserve did not announce its intentions. If a Fed-watcher or market participant wanted to know for certain if the FOMC adjusted monetary policy, the best they could do is see if measures of money supply increased or decreased. Weeks later the FOMC Minutes would be released, and the markets would know for sure what the Fed did at the previous meeting.

When the Fed became more transparent, the market focus on money-supply disappeared. This has now reversed as the stimulative money that had been injected into the economy to prevent undue weakness during the pandemic is now being methodically removed via quantitative tightening (Q.T.). The renewed focus on M2 is to make sure the Fed sticks with its plan. Signs that it may not be impact the amount of money available to chase goods and services, this impacts inflation.

The Fed’s battle to drain the cash put into the system, and do it in a way that doesn’t crash banks, or the overall economy is perilous, is continuing and well worth understanding.

May 2023

Solid Evidence a Recession is Unlikely this Year

Economists and news writers have been negative about the economic outlook, scaring people with the word recession since before the year even began. And while there are some weaknesses, the stimulative money supply is still exceedingly high, jobs are more abundant than workers, and home sales have not reacted as expected when mortgage rates rise from 3% to 7%.

The often-repeated line that the downward slope of the yield curve is a time-tested indicator of an impending recession was the echo chamber talking point that probably didn’t apply to this economy because of a novel Fed policy.

From a textbook position, those saying a negative yield curve indicates a recession got the answer right if they were taking a college quiz. However, those that were saying this inverted yield curve indicates a recession may have flunked. And if you copied off the economist next to you, and they somehow missed that the Fed owned 33% of all U.S. Treasuries outstanding, and because of their policy of yield-curve-control, the yield curve was not market-driven, and therefore not a reliable indicator of anything. What we know is that when the Fed buys one out of every three bonds, it leaves a mark on the area of the curve that they are active.

With higher than expected GDP released last week, most have stopped talking about a recession in 2023. We put out several articles beginning in 2022 explaining why others may have this yield curve indicator wrong, this is addition is most recent.

I highly recommend reviewing this article if your summer backyard barbecues include conversations about economic strength (or weakness).

June 2023

Why Small Cap Stocks Started to Attract Mega Cap Investors

Small Cap stocks had been lagging behind larger companies. Historically they are more volatile, but investors expect to be compensated over time for the additional risk they take. Yet, over a longer than normal period, they still lagged. This seemed to have changed; during the first week in June there were some days that small company returns had a little more giddy-up than they had in recent months or years. On June 6th we published the above article.

Small cap stocks finished the month well ahead of the large caps and even mega-cap companies. This momentum has carried into the second half.

Let’s Start the Second Half of 2023 Together

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I hope you found these six articles compelling, and if you have not registered for no-cost insights to your inbox each day, here’s your chance to start the second half with a slightly different investment angle.

Paul Hoffman

Managing Editor, Channelchek

What Investors Learned in June That They Can Use in July

Posted on by phoffman@channelchek.com

Looking Back at the Markets in June and Forward to July

Enthusiasm in the overall stock market was strong in June, the major indices were all up, and every S&P sector closed in positive territory. In fact, there was spectacular performance across market caps as Apple (AAPL) became the first company to reach a $3 trillion market cap, and noteworthy among small caps, Bitcoin mining company Bit Digital (BTBT) was up another 20% and a staggering 685% on the year during the last week in June. The across-the-board positive sentiment came during a month when the market was disappointed by the Federal Reserve’s continued hawkish bias.

Two dark clouds that the markets had hanging over them as they entered June were a possible U.S. default on debt and talk of a recession later this year. A higher debt ceiling law was signed on June 5, and a strong jobs report and higher-than-expected first-quarter GDP have for most, pushed most recession forecasts into 2024 or later. June’s performance may reflect a celebration and feelings of relief from both concerns.

Consumer confidence improved in June to its highest level since January 2022, reflecting a big jump in outlook and expectations. This surprise positive mood is reflected in stock market rotations experienced during June in both market-cap and market sectors.

Image Credit: Koyfin

Look Back

Four broad stock market indices were positive in June. In order, the Russell 2000 Small Caps, Nasdaq 100 Large Caps, the S&P 500 Large Caps, and the Dow Jones Industrials. Small cap stocks are the big winner in June as investors went looking for value. The Russell 2000 rose 8.07%. The smaller stocks may now have more positive impetus that could carry over into July as a report released last week by Goldman Sachs estimates that based on their models, small cap stocks could rise 14% over the next 12 months.  

While small cap stocks had their stars, the Nasdaq maintained a startling pace as big tech retained its appeal despite individual company market caps that have exceeded those of developed countries. The Nasdaq 100 was up 6.49% in June. The S&P 500 nearly matched Nasdaq with a 6.47% return. The Dow 30 Industrials, which have had a difficult few months, returned 4.56% to investors.

Source: Koyfin

Market Sector Lookback

Of the 11 S&P market sectors (SPDRs), even the lowest performer had an impressive one-month return. The chart above reflects the three best-performing sectors and the three worst. The performance indicates that there was a sector rotation away from defensive stocks during June.

Consumer Discretionary had the best return at 11.96%. By definition, these are companies selling products that consumers can cut back on or more easily avoid. The top ten holdings include Starbucks (SBUX), Bookings Holdings (BKNG), and Tesla (TSLA).

What S&P calls the Industrial Select sector finally came to life in June. Its 9.57% return represents almost all of this sector’s performance for the first six months of 2023 (9.73% YTD). Examples of top stocks contained in this index are John Deere (D.E.), General Electric (G.E.), and Union Pacific (UNP).

The third was Materials Select which was negative on the year heading into June. The 9.23% return on the month more than erased the negative 7.67% performance heading into the month.

Each of the top three performers is typically sectors that investors delve into when their economic outlook is more positive.

The three worst-performing sectors also indicate the month was very positive. The Health Care sector was the best of the bottom three at 4.51%. While this did not bring the sector positive on the year, companies like Johnson & Johnson (JNJ), Abbott Labs (ABT), and United Health (UNH), had experienced strong years this decade with growth drivers that have since weakened some.

The second to weakest performer is Utilities Select. Utilities are still negative on the year despite a 2.13% increase in June. Companies like American Electric Power (AEP), Dominion Energy (D), and Consolidated Edison (E.D.) are surrounded by a lot of uncertainty as their costs are driven more than other industries by fuel prices. Additionally, investors in utilities tend to be dividend stock investors. Dividend stocks tend to underperform in a rising interest rate environment as they compete less favorably with bonds.

The worst-performing sector provides further evidence of a rotation during June. Consumer Staples was the second-worst-performing sector at the close of May. While it returned 1.72% in June, the sector, which includes Colgate Palmolive (CL), Walmart (WMT), and Philip Morris (PM), usually gains in popularity when consumer confidence is low, it loses popularity as consumer confidence is high, that’s when, as we saw in June, consumer discretionary stocks get attention.

Looking Forward

The job market is strong, inflation is tapering,  and consumers are more confident. There are even signs that companies that have been waiting for an improved market to go public are considering now a good time for an IPO.

Bitcoin mining stocks and artificial intelligence are still be on fire. The crypto-mining stocks interest is tied to the price of Bitcoin – many of the stocks have actually outperformed the cryptocurrency. Artificial intelligence, as its potential becomes better understood, has inspired many to place bets that this will grow into a technology that is indispensable to many industries. Is the next Apple in this tech segment?

The rotation to small caps and sectors that perform better when the economy improves has a lot of momentum heading into July.

The next FOMC meeting is July 25-26; while market participants already expect further tightening, it has not deterred their positive view on the “risk-on” trade.

Take-Away

The market was jubilant in June. The signing into law of an increased debt ceiling helped kick off a change from the uncertain mood in May.  It unleashed buyers that continued even after it was clear the Federal Reserve was not finished hiking interest rates.

The year 2023 now sits at the halfway point. And within a few months, we will be in a presidential election year. Stocks tend to do well in election years. While the Russia/Ukraine situation is still uncertain, especially in the energy sector, the markets seem to have already priced in negative scenarios and are marching upward confidently.

Paul Hoffman

Managing Editor, Channelchek