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Volume 11, Edition 30 | October 10 - October 14, 2022

A Good Time for Evidence-Based Investing

Doug Walters, CFA
Market volatility is high as we try to navigate out of high inflation. But evidence-based investors sleep well at night, knowing we have tilted the odds in our favor for long-term outperformance.

Contributed by Doug Walters, David Lemire, Max Berkovich, Eh Ka Paw

Market watchers are getting whiplash. Last week, we saw stocks rally nearly 6% in two days. This week, there was a 5% rally within one trading day! Both events were followed by nearly as dramatic declines. Market volatility is high, and there is no reason to think it will change anytime soon. We see this as an environment ripe for evidence-based investors and full of pitfalls for both intentional and accidental speculators.

Intentional speculators are those making big bets on short-term market moves. Many of them are contributing to the recent ups and downs. These traders eagerly jump in while the market is in rally mode, hoping they are not the last person standing as it drops back down to earth. And the accidental speculators? Often they do not realize they are speculating. They are worried about volatility and respond by moving perceived riskier assets like stocks into cash. They see this as prudence in a challenging investing environment. They may get the timing right, but probably not. Such a move may reduce portfolio risk in the short term but increase the chance they derail their long-term returns. If you are sitting in cash on the day inflation surprises to the downside, watch out!

A better approach is what we call evidence-based investing. There is no one definition of evidence-based investing. We see it as relying on science, not speculation, to inform our investment decisions. It is not flashy, and you will not likely be heard bragging at the club about your science-based portfolio (although feel free to). The aim is to consistently tilt the odds in favor of outperforming the broad market over the long run. Higher returns equal a quicker path to reaching your financial goals.

What are some examples of evidence-based investing as we practice it?

  • Factors! We place stocks with academically proven attributes at the core of our portfolios. Good value, high quality, strong price momentum, and small companies are all proven to add to performance over time.
  • Diversification. It is the one free lunch in investing. Diversifying a portfolio with different geographies and asset categories can reduce risk and raise returns simultaneously.
  • Opportunistic rebalancing. Asset values in a portfolio move. Looking often for opportunities to rebalance surgically enables investors to sell high and buy low systematically.
  • Tactical tilts. Isn’t this speculation? No. There is a difference between swapping out your stocks for cash when emotions are high (speculation) and tilting the portfolio when you recognize an asset’s value is way off its historical range (science).

Markets like we are navigating these days are challenging enough without the worry of speculation. Evidence-based investors are not immune to losses, but we sleep well at night knowing we have tilted the odds in our favor for long-term outperformance.

5.1%

A big intraday stock market swing

Inflation had its way with the stock market this week, as stocks swung from down 2.5% to up 2.5% on Thursday.

Headline of the Week

The US stock market attempted to end in the green two weeks ago but could not hold on Friday. The CPI inflation data on Thursday came in hotter than expected. This would normally be a clear winner for our headline of the weak, but the data print was upstaged by the market reaction.

  • September CPI inflation came in at 6.6% on Thursday, ahead of expectations of 6.5% and up from August’s 6.3%.
  • This was not what investors wanted to see, and at the open, the S&P 500 fell about 2.5% from Wednesday’s close. But stocks were in for a wild ride, rallying over 5% throughout the day to close well in the green.
  • On Friday, those gains were nearly reversed, with the index down about 2.3%

Such is the nature of the market in these challenging economic times. So much hinges on expectations and the Fed’s ability to navigate a path to more moderate inflation.

The Week Ahead

China and Earnings will be in the driver’s seat next week.

The Gathering

The twice-a-decade gathering of the Communist Party of China kicks off on Sunday, and the week-long, closed-door affair is expected to give Xi Jinping a third 5-year term as supreme leader.

  • This will make Xi the country’s most powerful ruler since Mao Zedong.
  • The big picture… Xi will drive the “rejuvenation of Chinese nation,” which includes the “common prosperity” policies.
  • The zero-Covid policy has pushed the economy off track from its 5.5% growth target. Hopes of a reversal of the pandemic controls, or at least a softening, would be welcomed by markets.

What Did You Do?

In the middle of all the camaraderie on Tuesday, the 20th Party Congress will receive China’s 3rd Quarter Gross Domestic Product (GDP) reading.

  • The market expects a return to growth with month-over-month expansion in the economy of 3.5%, after the contraction the economy experienced in the previous quarter.
  • GDP growth of 3.4% is expected in the year-over-year number.
  • Economists expect that pent-up demand from the lockdowns in the 2nd quarter boosted spending in the 3rd quarter results.

Can You Do More?

The Peoples Bank of China is also due for a rate decision on Thursday.

  • It will be more about the non-rate stimulus the central bank may announce.
  • The preferred monetary tool in China is to inject liquidity into policy banks, not commercial banks, which helps local governments address the residential construction projects problem.
  • The consensus seems to be that traditional monetary tools aren’t the prescription for China’s ailment anyway.

The Big Boys

Earnings kicked off the prior week with Pepsi and big money center banks, but this upcoming week brings a bit more scope and maybe a better view of the global economy.

  • American Express (AXP), Goldman Sachs (GS), and Bank of America (BAC) continue the bank parade, but Tesla (TSLA), Johnson and Johnson (JNJ), and Procter & Gamble (PG) will bring a more diverse view on the world.
  • Pepsi (PEP) increased sales, despite declining volumes as it was able to charge more. Will PG and JNJ report the same? If, however, they report not only sales growth but also volume growth, that would be an even more appetizing quarter than Pepsi.

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