Market sentiment is something that has really piqued my interest lately. Since the day I started in the markets, I’ve constantly been told that investors’ expectations of future earnings is what drives the stock market. It wasn’t until I read an analogy, however, that the importance of this phrase truly clicked for me. In a well-known McKinsey & Company book called “Valuation” by Copeland, Koller, and Murrin the authors describe managing the finances of a public company like running on a treadmill. If you imagine the market’s expectations as the speed of a treadmill and a public company as the runner it begins to become more clear. When investor expectations become more bullish, the speed of the treadmill increases (and continues running at that speed). As a result, a company’s earnings/performance needs to be better than the market’s expectations in order to gain any ground on the treadmill (stock price increases). If they fail to beat these expectations, the runner begins to fall farther and farther behind the speed of the treadmill. However, it gets to a point where a company can have a history of beating expectations that the market’s expectations simply get raised too high. As a result, the most profitable company in the world may still experience a falling stock price by not being able to beat these unrealistic expectations.
A great example of this over the last week has been $AAPL. Everyone and their mother has written articles attempting to explain the falling share price of America’s beloved stock recently, and many of them may certainly be right. To me, however, the answer is simple. $AAPL has done so well over the years that expectations have simply gotten too high. One slip up in iPhone 5 sales and we’ve experienced a massive sell-off in the stock. Tim Cook and company just couldn’t continue running 5 minute miles.
Thankfully, I’m not hear to rant about $AAPL. The treadmill analogy has caused me to pay a lot more attention to market expectations recently. I think we can all agree the month or two leading up to Fiscal Cliff shenanigans consisted of some very bearish expectations. Surprisingly, all of the press during this time almost completely disregarded the Euro Crisis. I find it pretty hard to believe that Angela Merkel’s quote regarding the health of the EU has finally been listened to and acted upon by businesses and investors. Nevertheless, we saw a nice rally in European equity indexes and especially select financials ($SAN is my current favorite). Further, once January 1st came and went we’ve seen a nice pickup in US Equity markets as the majority of financial blogs have began focusing on the 2013 bull market…
Despite the large number of bullish articles and posts this weekend, bloggers/journalists are beginning to second guess themselves. Debates about a secular bull market and fake rallies have all been argued for today. Frankly, the vast majority of bullish articles have come in the last week and I can’t find any reasons why the bearish arguments (from former bullish investors, writers, and ranters) came out of the blue today. While this has caused me a great deal of confusion, I think it’s actually a good sign. It’s still very early in earnings season which means the bearish sentiment should give rise to some nice rallies after healthier than expected companies end up beating estimates. $IBM was today’s prime example. I’m hoping for a nice little sell off in order to pick up some names I’m confident in before they announce earnings and hopefully fetch some nice gains.
From here on out, I’ll be using this blog as a trade journal as well as to clear my thoughts and observations on the markets. More to come this week!