The thrill is gone

The sirens never sound to tell you when the tide is about to turn.

For the better part of a decade Wall Street has been in glass half full mode. Not at every moment, and not every company, but there was a substantial benefit of the doubt given to most companies.

I was a little surprised last week by the market’s reaction to Palantir’s earnings. I’ve picked on Palantir enough here and won’t rehash the quarter. It was fine. But it in no way (in my opinion) justified anything approaching the company’s valuation. Palantir beat estimates by a penny, and revenue by $3 million (on a $558M quarter). But I was fully expecting an oversized reaction to the beat regardless.

Palantir did jump, but it failed to recapture levels seen as recently as August. Something has changed.

Granted, one data point does not make a trend. But there’s an interesting report out from FactSet which makes the case that something is indeed going on here. This quarter, S&P 500 companies have seen the largest negative price reaction to EPS misses since 2011. And an underwhelming reaction to beats.

The numbers:

• Companies that have reported positive earnings surprises this quarter have seen an average price increase of 0.8% two days before the earnings release through two days after the earnings release. The five-year average is a 0.9% jump.

• Companies that have reported negative earnings surprises for Q3 2023 have seen an average price decrease of 5.2% during the same window. That decline is significantly higher than the 5-year average of a 2.3% drop.

• You have to go back to the first quarter of 2011, when negative surprises led to an 8% drop, to find a more pronounced decline.

The benefit of the doubt is no more.

So, what’s going on here? The most obvious place to start is interest rates. As said before, I continue to believe there are a lot of businesses that have been very popular in recent years that potentially no longer make sense now that free money is gone. The overall direction of the market would suggest that hasn’t fully sunk in yet. But trends take time to build, and it appears investors are becoming more skeptical.

It doesn’t mean everything is going to zero. But it takes great confidence to bid valuations up to historical highs. It takes either courage or ignorance to bid them higher from there. Tesla trades at more than $300,000 per vehicle it intends to deliver this year. Perhaps you can model your way into believing that future growth will justify that valuation. But it takes another model altogether to believe it can go substantially higher from here in the meantime.

I hate market predictions. Also, I’m bad at making them. Anyone who based their 2023 investing on what I thought would happen is mad at me now. But I don’t believe interest rates are retreating anytime soon, and I don’t see how the benefit of the doubt will return until there is an easing.

So, what should you do? The answer, as always, is mostly to ignore. The goal is to find companies to invest in for decades, where the turning cycle should not be cause for concern. But it might be a good idea to take a sober look at your portfolio to make sure there isn’t anything in there that has been propped up by previous conditions.

I’ll confess I have bought a lot less this year than I might normally, in part because when you see the world as I do things tend not to look attractive at this point.

The other important step right now is mental. Prepare for what could be to come. Don’t allow yourself to be caught off guard by the inevitable.

We’ve had a great run thanks to zero rates and free money. Almost great enough to believe in new normals and to forget that all pendulums eventually swing back. The worst decisions are made during those moments we are caught off guard as things go wrong.

We can survive and thrive through the next wave. But we have to be at peace with the knowledge that we can’t prevent it.

Disclaimer: Fits and Starts DOES NOT provide financial advice. All content is for informational purposes only. Stocks mentioned are as reference only, and a mention should not be interpreted as a buy or sell recommendation. The author is not a registered advisor or a broker/dealer. DO YOUR OWN HOMEWORK. The information contained within is not and should not be construed as investment advice, and does not purport to be. The red zone has always been for loading and unloading of passengers. There’s never stopping in a white zone.

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