Sorry, but investing is complicated 😭
Sorry, but investing is complicated 😭
Plus a charted review of the macro crosscurrents 🔀
📈 Stocks rallied to new all-time highs, with the S&P 500 setting a record intraday high of 5,523.64 on Friday. For the week, the S&P shed 0.1% to end at 5,460.48. The index is now up 14.5% year to date and up 52.6% from its October 12, 2022 closing low of 3,577.03.
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I do my best to make complex topics accessible for stock market investors of all levels.
In that effort, I try to avoid oversimplifying concepts that are unavoidably complicated.
This issue came up this past week in my discussion with Jared Blikre and Sydnee Fried on Yahoo Finance’s “Stocks In Translation” podcast. (Listen to it on Spotify or watch it on YouTube!)
Specifically, we were discussing the various ways people talk about earnings, which is also referred to as income, profits, or “the bottom line.”
Discussions around earnings can get complicated 😵💫
All publicly traded companies have to report net income as calculated according to generally accepted accounting principles (GAAP), which are defined by the Financial Accounting Standards Board. It’s a rigid measure that accounts for arguably unusual items like the realized gains or losses on a big asset sale and the unrealized gains or losses on the market value of something the company owns.
Some managers argue that financial results according to GAAP don’t always reflect the underlying health of the ongoing operations of their companies. So they’ll opt to provide adjusted, or non-GAAP, results alongside the GAAP results.
The issue with non-GAAP results is that they are largely calculated at the discretion of a company’s executives, who may be incentivized to make adjustments that make the company look much stronger than it really is.
In his 2023 annual letter, Warren Buffett cautioned against reading too much into adjusted earnings as they can “easily be manipulated by managers.”
Though on the other hand, when discussing the financial performance of his company Berkshire Hathaway, Buffett often advises investors to focus on an “operating” earnings figure that adjusts for unrealized gains and losses on the company’s stock portfolio.
It all speaks to how nuance matters in discussions about earnings.
There isn’t a single right or wrong way of calculating a company’s earnings. And this is a big deal because earnings are the most important driver of stock prices.
Investing is complicated 🤕
“A lot of what you’re saying must be really confusing for new investors,” Sydnee said to me. “A lot of these terms are similar: GAAP, non-GAAP, profit… How do you cut through all that language when someone is trying to simplify something for you?“
“There’s a point where you can’t simplify it any more,” I said. “Because at the end of the day, investing is complicated.”
I’m glad Sydnee and Jared raised this issue, because oversimplifying a complex issue can sometimes be a dangerous disservice to whomever is listening.
Consider some of these simplified statements:
Rising interest rates are bad.
A falling saving rate is bad.
Fed rate cuts are good.
An inverted yield curve precedes recessions.
Above-average valuations mean stocks are expensive.
High market concentration is risky.
There’s some truth to each of these statements. But they all lack important nuance that would help explain why any or all of these things can be happening while the economy continues to grow and the stock market continues to go up.
I won’t go into each statement. If you’re interested in going deeper, I suggest reading:
Whether or not the Fed cuts rates is not the right question 🔪
At new all-time highs, the stock market has actually gotten cheaper 🤯
By the way, TKer.co has a great search function in the upper right corner of every page. Type in a keyword to browse the archives!
The big picture 🖼️
If investing were simple, everyone would be doing it confidently. And people like me would be out of work.
I’ve been researching and writing about markets for 18 years. I also have a professional designation: CFA Charterholder. And yet I continue to learn new things about investing almost every day.
In your pursuit of becoming a better investor, if you’re finding some of this stuff to be complicated, then you’re probably doing something right. Because investing is complicated.
Check out my whole appearance on “Stocks in Translation” here:
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Related from TKer:
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
🎈 Inflation trends need to cool more. The personal consumption expenditures (PCE) price index in May was up 2.6% from a year ago, down from April’s 2.7% rate. The core PCE price index — the Federal Reserve’s preferred measure of inflation — was up 2.6% during the month, matching the lowest print since March 2021.
On a month over month basis, the core PCE price index was up 0.1%, down from 0.3% in the previous month. If you annualized the rolling three-month and six-month figures, the core PCE price index was up 2.6% and 3.2%, respectively.
Inflation rates have a little more to go to get to the Federal Reserve’s target rate of 2%, which is why the central bank continues to indicate that it wants more data before it is confident that inflation is under control. So even though there may not be more rate hikes and rate cuts may be around the corner, rates are likely to be kept high for a while.
For more on inflation, read: Inflation: Is the worst behind us? 🎈
⛽️ Gas prices tick up. From AAA: “The national average shook off nearly three weeks of stagnation, moving a nickel higher since last week to hit $3.50. The move came as the cost of oil crossed the $80 per barrel mark, putting upward pressure on pump prices. With oil costs accounting for about 54% of what you pay at the pump, more expensive oil usually leads to more expensive gas.”
For more on energy prices, read: Higher oil prices meant something different in the past 🛢️
🛍️ Consumers are spending. According to BEA data, personal consumption expenditures increased 0.3% month over month in May to a record annual rate of $19.34 trillion.
Adjusted for inflation, real personal consumption expenditures rose by 0.3%.
For more on resilient spending, read: There's more to the story than 'excess savings are gone' 🤔
💳 Card spending is holding up. From JPMorgan: “As of 21 Jun 2024, our Chase Consumer Card spending data (unadjusted) was 0.4% above the same day last year. Based on the Chase Consumer Card data through 21 Jun 2024, our estimate of the U.S. Census June control measure of retail sales m/m is 0.34%.“
From Bank of America: “Total card spending per HH was up 0.4% y/y in the week ending Jun 22, according to BAC aggregated credit & debit card data. Retail ex auto spending per HH came in at -1.7% y/y in the week ending Jun 22. June card spending looks stable. The retail ex autos decline was likely driven by department stores, lodging & furniture.”
For more on consumer finances, read: Unsettling stats about consumer health are missing the bigger picture 💵
👎 Consumer confidence deteriorates. The Conference Board’s Consumer Confidence Index in June ticked lower. From the firm’s Dana Peterson: “Confidence pulled back in June but remained within the same narrow range that’s held throughout the past two years, as strength in current labor market views continued to outweigh concerns about the future. However, if material weaknesses in the labor market appear, Confidence could weaken as the year progresses.“
From the University of Michigan’s June Surveys of Consumers: “While consumers exhibited confidence that inflation will continue to moderate, many expressed concerns about the effect of high prices and weakening incomes on their personal finances. These trends offset the improvements in the short- and long-run outlook for business conditions stemming in part from expectations for softening interest rates.“
Weak consumer sentiment readings appear to contradict resilient consumer spending data. For more on this contradiction, read: What consumers do > what consumers say 🙊
👍 Labor market confidence improves. From The Conference Board’s June Consumer Confidence survey: “Consumers’ appraisal of the labor market improved in June. 38.1% of consumers said jobs were ‘plentiful,’ up from 37.0% in May. 14.1% of consumers said jobs were ‘hard to get,’ down from 14.3%.“
Many economists monitor the spread between these two percentages (a.k.a., the labor market differential), and the trend has been reflecting a cooling labor market.
For more on the labor market, read: The hot but cooling labor market in 16 charts 📊🔥🧊
💼 Unemployment claims fall. Initial claims for unemployment benefits declined to 233,000 during the week ending June 22, down from 239,000 the week prior. And while this is above the September 2022 low of 187,000, it continues to trend at levels historically associated with economic growth.
For more, read: Labor market: How cool will it get? 🥶
🏠 Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage declined to 6.86% from 6.87% the week prior. From Freddie Mac: “The 30-year fixed-rate mortgage continues to trend down, hitting the lowest level in almost three months. By historical standards, the economy is in good shape, and we expect rates to continue to come down over the summer months, bringing additional homebuyers back into the market.”
There are 146 million housing units in the U.S., of which 86 million are owner-occupied and 39% of which are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged from 2021 lows. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.
For more on mortgages and home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
🏠 Home prices rise. According to the S&P CoreLogic Case-Shiller index, home prices rose 0.3% month-over-month in April. From S&P Dow Jones Indices’ Brian Luke: “2024 is closely tracking the strong start observed last year, where March and April posted the largest rise seen prior to a slowdown in the summer and fall. Heading into summer, the market is at an all-time high, once again testing its resilience against the historically more active time of the year.“
For more on home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
🏘️ New home sales fall. Sales of newly built homes fell 11.3% in May to an annualized rate of 619,000 units.
For more on housing, read: The U.S. housing market has gone cold 🥶
🏠 Who builds the house? Here’s a cool graphic from BofA showing the average costs of various components of a house including the companies providing those products.
🏭 Business investment activity ticks down. Orders for nondefense capital goods excluding aircraft — a.k.a. core capex or business investment — fell 0.6% to $73.55 billion in May.
Core capex orders are a leading indicator, meaning they foretell economic activity down the road. While the growth rate has leveled off a bit, they continue to signal economic strength in the months to come.
For more, read: The economy has gone from very hot to pretty good 😎 and 'Check yourself' as the data zig zags ↯
🇺🇸 Most U.S. states are still growing. From the Philly Fed’s May State Coincident Indexes report: "Over the past three months, the indexes increased in 46 states, decreased in three states, and remained stable in one, for a three-month diffusion index of 86. Additionally, in the past month, the indexes increased in 38 states, decreased in eight states, and remained stable in four, for a one-month diffusion index of 60.”
📈 Near-term GDP growth estimates look good. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.2% rate in Q2.
For more on economic growth, read: Economic growth: Slowdown, recession, or something else? 🇺🇸
Putting it all together 🤔
We continue to get evidence that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to get inflation under control. While it’s true that the Fed has taken a less hawkish tone in 2023 and 2024 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened, inflation still has to stay cool for a little while before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for relatively tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have recently had some bumpy years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
High and rising interest rates don't spell doom for stocks👍
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
Most pros can’t beat the market 🥊
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 in 2023. As you stretch the time horizon, the numbers get even more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 87.4% underperformed. And over a 20-year period, 93% underperformed. This 2023 performance follows 13 consecutive years in which the majority of fund managers in this category have lagged the index.
Proof that 'past performance is no guarantee of future results' 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 334 large-cap equity funds were in the top half of performance in 2021. Of those funds, 58.7% came in the top half again in 2022. But just 6.9% were able to extend that streak through 2023. If you set the bar even higher and consider those in the top quartile of performance, just 20.1% of 164 large-cap funds remained in the top quartile in 2022. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2023.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
