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TBG Monthly Market Color

Dear Friends,

  • Over the past two weeks, the market has seen headlines and fears of slowing economic growth.
  • Despite these legitimate concerns, there have been pockets of out performance that can be captured through investments in individual companies  – an area we seek to take advantage of.
  • In the public markets, investors must consider both valuations (i.e., the multiple the market is willing to pay for a company’s stream of profits) and the forecasted estimates of a company's revenue and profit.
  • Regarding valuations, we believe recent results suggest valuations are starting to stabilize.
  • Specifically we observed that companies that have sold off sharply to start the year have rebounded on quarterly results that were largely in line or even below expectations.
  • Notably, Facebook, PayPal, and Texas Instruments all saw share price rallies after a reduction in estimates (see Figure 1 below for a chart on earnings revisions vs. stock price reaction on the day of earnings).
  • However, there are concerns of slowing economic growth, which would pressure economic and company estimates.
  • Economists and investors find it challenging to forecast the slowing demand because of the large step up in profits we’ve seen in the S&P 500 since 2019 (see Figure 2 for a chart of S&P 500 Earnings per Share over time).
  • To give a real-world example, Home Depot, the home improvement company, did $110B in sales in calendar 2019 – last year it did ~$150B, a 35+% increase in two years, driven perhaps by sustainably strong housing demand.
  • Some of this increase is also explained by the rise of prices. And on the positive side, we note the US consumer remains healthy with about $2 Trillion in excess savings accumulated since the pandemic began per recent reports.
  • Still investors are struggling with what a good baseline is and what multiple that should trade for.
  • Over the history of the US markets, on average recessions have caused about a 15% contraction in company profits from the pre-recession peak to the recession trough (see Figure 3).
  • Once the recession hits and the recovery begins, forward estimates have on average landed about -3% below the prior pre-recession peak. So typically, all economic progress is not lost during a recession, though the magnitude varies as you can see.
  • Finally, Figure 4, looks at historical performance of Russell 1000 Growth vs. Russell 1000 Value indices. We note the strong long-term track record of growth and believe investors could benefit from exposure here in a period of contraction.

As always, please reach out with any questions or if you're interested in learning more about our strategies.

 Thank you,

The Bycoff Group

Sources: Figure 1, Figure 2 and Figure 4 pricing and estimate data per Bloomberg, Figure 3 per BofA research.