2023-12-17 09:00:00 ET
Summary
- Mott Capital Management's Michael Kramer analyzes market anticipation for 2024 earnings growth and implied volatility levels.
- He believes that the market's expectation of a 10% earnings growth next year is unlikely due to inflation and margin contraction.
- Kramer suggests that there are undervalued pockets in the market that present opportunities for investors, particularly in sectors that have been beaten down.
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Mott Capital Management's Michael Kramer is looking at 2 things: what the market's anticipating for 2024 earnings growth and implied volatility levels (0:20). Finding (and getting in front of) extremely undervalued pockets in the market (3:20). This is an abridged conversation from Seeking Alpha's recent Investing Experts podcast .
Transcript
Rena Sherbill: On Seeking Alpha, you run Reading the Markets , that's your investing group. Your author name on Seeking Alpha is Mott Capital Management . Michael Kramer, great to have you on the show today.
Michael Kramer: Investors for the most part, from the way I can look at it, and the only way I can look at it is two things. I look at what is the market anticipating in terms of earnings growth for next year, and then I look at implied volatility levels, which tells me some sort of level of complacency or fear in the market.
A VIX at 14 is obviously suggesting there's no fear in the market. There's a lot of complacency, understanding what I understand about spreads and economics would tell me that the VIX is probably too low and will need to rise in 2024.
The other thing is that earnings are expected to grow by 10% next year, which I don't see as a possibility given that, number one, inflation is coming down, right, which is clear. We know that. I don't think anyone has been a denier of the fact that we know that inflation rates are falling. It's obviously the pace at which they fall and where they get stuck perhaps along the way.
But what seems clear to me is that probably by the time we get to the second half of 2024, you're going to see inflation approaching that 2% target. And what that means though is that companies will no longer have pricing power to pass onto the consumer anymore, which means they won't be raising prices, which means that the whole reason, the whole way that the market gets to this 10% earnings growth rate is through profit margin expansion.
But if you can't increase prices anymore and you have employment costs rising, as noted by a higher average hourly earnings and higher inflation due to medical costs or health insurance, then we know that margins can't expand and margins will need to contract.
And so if you get a 5% sales growth number, you need margin expansion to get you to a 10% earnings growth number. And what we're already seeing for the fourth quarter estimates is you've seen fourth quarter sale earnings growth rates come down by about 4 percentage points since beginning of October, and you've seen margin compression already showing up in fourth quarter numbers.
And so I expect that to spill over into 2024. You're beginning to see it in the first quarter, but it's very slow to mature at this point. And I expect that those numbers will begin to reflect that as well in the 2024 number.
And so if you're going to see an economy really slowing and a GDP growth rate coming off of a sugar high 8%, it just tells me that you're not going to see a 10% earnings growth rate next year. And all of a sudden, an S&P 500 trading at 18x or 19x next year's earnings with a sub-10% growth rate is going to be a very hard multiple to maintain.
RS : So in terms of moving forward, do you feel like investors looking at the different sectors, is there something to be gleaned at this point from kind of, I mean, we talked about the AI mania and the disappointment that came from that.
Is there something that you feel like is getting frothy or too frothy?
MK : So my approach to investing in 2023 has been to be defensive. And what I mean by being defensive is owning what I've done personally is own high-quality stocks. And I've used opportunities where the market has moved up to raise more cash to earn my risk-free rate of return in my money market account.
And so what I've also sort of discovered over this last couple of months is that you've seen basically just one part of the market really lead the way. I was just doing an analysis actually this morning and essentially you strip out the top seven names. The S&P 500 has no performance this year, right? It's completely flat.
When you strip out the top seven names, the NASDAQ composite basically has no performance this year, right? When you look at the number of stocks that are down double digits as opposed to the number of stocks that are up double digits in the NASDAQ composite, the number of stocks down double digits far outweighs the number of stocks that are up double digits in the NASDAQ. The same goes for the S&P 500.
And so what it tells me is that there are pockets in this market that are probably extremely undervalued, right, because they've just been unfairly beaten up.
The question becomes obviously is when is the right time to really pull the trigger and get in front of that, because the frothy names, which are some of the high-quality names that I actually own, like the Apples ( AAPL ) and the Microsofts ( MSFT ) and the Amazon ( AMZN ) and the Alphabets ( GOOG ), which have done really well, are clearly holding this market up, right?
And at some point, I think, you're going to see that rotate out, because these companies aren't, I mean, I've owned them for years. I know that they're not immune to economic cycles , as many people seem to be betting right now, right?
And so what that tells me is that not that you should be a seller of these names, because I don't advocate selling these. I think that these are too ingrained in our lives and they're too important in our lives that they're positions that you just need to be a part of and just hold on to.
But that if you, from my perspective, that I'm beginning to look for parts of the market that are just deeply oversold at this point, right, where valuations are so low that historically, even if we do go into a recession, there's the possibility that these companies could at least not go down any further.
And those are the types of opportunities that I think exist right now, because I think a lot of bad news has already been priced into things like biotech. I think a lot of bad news has been priced into things like financials. I think a lot of bad news has been priced into things like even utilities, right, because rates have gone up so much.
And even when you look at consumer discretionaries, I mean, you take out Tesla ( TSLA ), you take out Amazon ( AMZN ), where would the ( XLY ) be, right? I mean, because the consumer discretionaries retailers have done horribly because they're - they've been getting crushed.
But - so there are opportunities even there, even in staples. I mean, because again, like a lot of these stocks have just been really beaten up because of fears of margin compression and the economy slowing down and they've been left behind. And they're more, again, representative of the broader market when you take out the top seven. And that's really what this is about at this point.
I just think that this is a precarious time. And I think that investors shouldn't be so quick to assume that because something didn't happen the moment that it was supposed to happen, that that means it's not going to play out a certain way. I think investing takes a certain mindset.
The idea for me, at least, is to not burn myself out, right, is that I want to be in this for the long term. I want to be in this for the long game. I hope to still be doing this hopefully when I'm 76, as opposed to being 46 with the same energy level and the same vigor, because I try to think about everything I do with a long-term perspective and preparing for the future.
And that means going through every single thing on a regular basis, on a short-term basis to be able to do that, so that you don't really feel that stress when the time comes.
And I think too many investors are too short-term focused today because everything moves so quickly. They feel like they have to be in it at every moment of time. And the truth of the matter is you really don't. My biggest mistakes have come when I've chased the market because I got emotional, and that has really hurt me at times.
So my key takeaway is try not to be emotional, try to have patience , and try to really be focused on the longer term, because I think that's really what drives real wealth generation, not this short-term day trading stuff. But that's coming from someone that's been around for 30 years and has had a lot of different roles on Wall Street.
RS : Yeah. The notion of investing versus trading is something that we talk about a lot. And yeah, I think, if you do either one, you need to build wisdom and you need to dance that dance of resilience either way. But yeah, I think a lot of nice insights there for listeners.
On Seeking Alpha, you run Reading the Markets , that's your investing group. Your author name on Seeking Alpha is Mott Capital Management . Anywhere else listeners, the audience can find you?
MK : So I have a big Twitter following. You can follow me on Twitter @MichaelMOTTCM . I post everything there. So I mean, if you want to follow me, that's the easiest way to make sure you're not missing anything. I also post some insights on there as well.
I also do post a lot of stuff throughout the day on my chat room on the Reading the Markets forum as part of the Seeking Alpha Investing Groups . I try to bring the same approach to the Investing Group that we've just had this conversation about. And so if you enjoy this type of view, then this is certainly a place that you want to check out. And I'm a guy that likes to get into the weeds a lot.
For further details see:
Looking At VIX And Earnings Growth With Mott Capital Management