Distinguishing Signal from Noise – July 26, 2019

Distinguishing Signal from Noise – July 26, 2019
Morgan Lewis Posted on July 26, 2019

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Distinguishing Signal from Noise

We are in the midst of earnings season, and the enormous amount of data we are receiving and processing from the companies in terms of financial updates and conference calls is like drinking from a fire hose. I wish I could say that there is a consistent theme within the hard assets strategy in terms of what our companies of interest are saying, but, thus far, operational and financial updates have been very much on a case-by-case, stock-specific basis. We are being opportunistic in building out each of the MAPS strategies, and while getting updates and understanding what is happening on a quarter-to-quarter basis is important, we are much more focused on whether companies of interest are executing on their long-term business strategies and building value. We ask ourselves – are the decisions the company is making consistent with what they have articulated in the past? If not, are they responding to a change in the business environment?

Often times during earnings season, an exogenous event completely outside of the control of the company can create an opportunity. Weather is a great example, as it is a variable that is completely unpredictable (despite what your local TV weatherman might lead you to believe), but it often can lead to short-term declines in demand within the business and impact quarterly earnings, which are inherently backward looking. This can sometimes allow us to take advantage of the short-term nature of a sell-off spurred by hot-money speculators who punish a company for “not hitting the numbers” if we understand that it is not impactful to the business longer-term and believe that the outlook for the business is still favorable. We always like to have some “dry powder” in order to be able to take advantage of this dynamic. Great students don’t always achieve straight As, and we do not believe that a B on the test represents failure, especially if we know that the process and discipline within the company remain consistent, and it is still poised to generate long-term returns on invested capital. On the other hand, companies that produce results and/or a business outlook that suggest a significant deviation from their core focus or articulated business strategy give us reason to reevaluate the investment.

In the meantime, there is a bit of a market rotation that is occurring. Yield-sensitive stocks that benefitted from the melt-up in the 10-year Treasury have continued to experience a pullback; even those companies that have gotten past earnings with beat and raise quarters. This phenomenon is more a function of ETF capital flows than any company specific attribution. We are optimistic that this will give us an opportunity to continue to build out the hard assets strategy where company fundamentals coupled with attractive value intersect.

The vast majority of this rotation is a function of the anticipated actions of central banks globally. Most importantly, all eyes are on the Federal Reserve and its upcoming meeting. It is highly anticipated that a 25bp rate cut is in the offing, down from the 50bp that people had expected just a handful of weeks ago. Hence, the rotation in the market as discussed above. These types of things really should not dissuade us from the essential nature of our strategy. Often, our company investments have competitive “moats” around them, and, despite the macroeconomic noise, can prosper as their returns on capital remain high. That is what matters in the long run. We expect to opportunistically invest in these businesses. Consistency of one’s approach matters, grounded in essential fundamentals.

Best Regards,

David McAlvany
Chief Executive Officer

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