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May 21 2024

Unlocking Value With “Name & Shame”

  • May 21, 2024

The financial performance of Korean companies has retreated to distressingly low levels in recent years. Consider that 67% of KOSPI index members trade at a P/B below 1x, and the median ROE is just 4.9%.  To address the concerns of fading corporate performance, low valuations, and weak stock market returns, the Financial Services Commission joined with the Korean Stock Exchange to announce the “Corporate Value-Up” program in February 2024. The objective is to enhance corporate governance and shareholder accountability and to encourage companies to improve financial performance in the areas of P/B, ROE, ROA and shareholder payouts.

Read this week's Major Trend. 

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The latest CPI report was boring, but no bad surprise is really good news these days. Our scorecard is currently Neutral and it’s likely on the cusp of turning disinflationary over the next few months.

 

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One casualty of the U.S. market’s hawkish turn is the Japanese Yen. It certainly grabbed its share of headlines, yet, when viewing the selloff in historical perspective, this year’s uptick looks entirely inconsequential. Additionally, when considering the Yen through the lens of other Asian currencies, its outsized weakness versus the dollar essentially disappears. Dollar strength is the real driver and it has pummeled Asian currencies across the board.

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Now at the bull market’s one-and-a-half-year mark, it’s notable that every major stock index has trailed the average path for a new bull market at this point in a cycle. But, it’s unfair to liken today’s bull with past bulls, because it has a unique adverse trait that is apt to be life-shortening: It arose during an economic expansion—and likely in the latter stages, considering the unemployment rate was 3.5%.

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Despite our reservations about the durability of the expansion, we have to respect what it has overcome: interest-rate hikes of 425 bps; a nearly 2-year runoff in the Fed’s balance sheet (QT); and a 9-month bear market that began before the expansion reached its 2-year milestone. Even consumer “expectations,” which track the market higher in the early phase of a bull market, never rebounded and are lower now than at the fall-2022 market low.

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Despite a hostile setting for active management in Q1, six of nine style boxes in our ongoing analysis achieved active-fund win rates above 50% (60% on average bested their passive benchmark). The other three each scored just below 50% of active strategies beating passive. This is remarkable given the proven importance of market conditions in the active/passive performance derby.

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Q1 bottom-up S&P 500 operating EPS estimates jumped a little over a dollar to $55.36 after the first month of reporting. This halted the usual “slow-erosion” pattern that shaved $3 off the quarter’s estimate since last summer (Chart 1). The three forward quarters of 2024 also experienced a bump in estimates. S&P 500 full-year EPS projections now sit at $242. That would be a 13% YOY gain from 2023’s results.

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Our March report titled Lifeboat Drill examined the effectiveness of sectors, styles, and factors in protecting investors during major market declines. We found that Consumer Staples are significant and consistent outperformers during times of distress, serving as “comfort food” for investors trying to minimize their financial and emotional distress in a falling market.  Staples are relatively inexpensive today based on market-relative metrics, and today’s level of cheapness has historically corresponded to positive relative returns going forward.

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CPI readings were a touch above estimates again in March. The actual data surprises are not nearly as dramatic as the market reactions, which have been almost entirely driven by sentiment swings.

 

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The market upswing is now confirmed by Cyclicals, Defensives, Breadth, and Bonds. Endorsement by all four occurs about one-third of the time and has led to an S&P 500 average annualized compound return of +15%.

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Realizing a gain in each of the first three months of the year, like Q124, is not as bullish for the next twelve months as are back-to-back gains in January and February. The three-month streak produces a one-year performance advantage of around 2%, while a string of Jan-Feb gains was additive by 900 bps. 

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Rallies of this magnitude (+30% in 5-6 months) are not uncommon; however, this one began one year into a yield-curve-inversion cycle and with stock valuations already elevated. The latter condition could be viewed as a positive because the market surge has created one of the most pronounced short-term wealth effects in history.

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To gauge how much faith we should have in this “virtuous” cycle, we examine the macro context in terms of the business cycle, the Yen, interest rates, and inflation. Ultimately, inflation holds the key to bond yields, as the main difference between pre- and post-1990 rate hikes boils down to inflation—which is also the key determinant of how far the BoJ can go in this tightening cycle.

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This month’s Leuthold Refresh is a quarterly update on our factor regime analysis. Factors, or investment styles, have historically performed quite differently under various economic and market conditions, and we’ve mapped these relationships to identify the factors best positioned for the environment at this time.

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Well-respected analysts have been espousing different views on the Staples sector’s overall valuation. Some argue Staples is rather richly priced, while others believe it is a bargain in the making. Disagreement creates opportunities, and we believe a closer look at Staples is in order.

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ETFs that focus on a single sector, style, or theme enable investors to make tactical calls that reflect their outlook and risk tolerance, resetting their risk/return profile to benefit from prevailing economic and market conditions. As fate would have it, the explosion of tactical, thematic funds that began 15 years ago coincided with a drought in market cycles.  Following the Global Financial Crisis, the S&P 500 only experienced one moderate drawdown in the next nine years, meaning that opportunities to judge these new thematic ETFs during market declines were in short supply.  This dearth of real-world corroboration has been remedied in recent years as the market experienced three major declines in the span of 49 months, and this expanded sample size serves as the basis for our current study evaluating defensive ETFs in down markets.

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Like January, February’s CPI figures were hotter than expected. Stickier inflation data, spiking breakeven rates, and fewer Fed cuts haven’t scared the equity market one bit.

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Factor performance was decidedly risk-on in February. Through month end, high-momentum names have outperformed the universe by 6.7%—we have to go back to the Tech Bubble to find a year when momentum had a stronger start.

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Improvement in bank lending trends should be a tailwind for economic activity, while steeper yield curves also imply a looser lending environment lies ahead. Another area supporting U.S. economic resilience is the wealth effect: The surging wealth effect is boosting consumer confidence which, in turn, leads to higher consumption.

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It’s been 26 months since the all-time peaks the NYSE Weekly and Daily Advance/Declines Lines. The weakness in the Daily version is especially troublesome given the strong upward bias it’s exhbited since 2001. In addition, figures for 52-Wk. New Highs and New Lows have been anemic relative to the major index gains—especially among NASDAQ stocks.

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Breadth and leadership of this bull market have fallen short of the typical patterns of early-cycle bulls, even if contrasted only to other new bulls that did not emerge from recessionary lows, like 1962-66 and 1987-90. Still, participation looks broad enough that the odds are against an imminent cyclical peak.

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Mentions of the yield curve by the financial media and market pundits have plummeted the last few months. That’s understandable, but dangerous. We remember the same happening in 2007—with one of the more memorable dismissals coming from Fed Chair Bernanke.

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We are curious if factor ETFs have provided downside protection in recent years’ selloffs or whether their defensive nature, shown by academic studies, is lost in the translation to live-money portfolios.

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On its face, the second month of Q4 reporting was much more positive than the first. After sagging in January, the S&P 500 bottom-up EPS estimate rose back to $54—almost exactly where it stood before Q4 announcements got underway (Chart 1). With just a few stragglers left to report, full-year 2023 EPS will come in at $214. That’s almost 9% better than 2022’s final result.

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Read this week's MTI update.

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Real Estate was the top performing sector in the final quarter of 2023, climbing an impressive 18.8% against the market’s 11.7% gain.  Signs of enthusiasm for the REIT industry have been rare in recent times.  While the S&P 500 gained 96% over the last five years, REITs returned a paltry 31% over that time.  We wondered if last quarter’s success signaled that it was time to take a fresh look at the group.  This report examines the investment merits of REITs as an asset class, using the mental model of evaluating “what you pay vs. what you get.”

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CPI readings were a tad hotter than estimates again in January. Given the speed of disinflation that’s currently priced in by the market, we are probably headed toward a period of expectation adjustment.

 

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It’s too soon to know if the October low for small caps will stand, but it would have been a better, more buyable low if it had been accompanied by a recession. It’s all about “initial conditions.” Russell 2000 lows associated with recessions bottomed with a normalized P/E multiple nearly five points below that of the median multiple for non-recessionary lows—and subsequently gained an average of 185% versus +75%.

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The stock market remains “externally” strong, with the S&P 500 and DJIA at new all-time highs on February 2nd.  However, the YTD performance gap between the S&P 500 and the Russell 2000 is already 8%—the worst five-week start ever for Small Caps on a relative basis. And, on a trailing 12-month basis, the percentage of S&P 500 stocks outperforming the index, itself, is the lowest on record at just 25.6%. That’s made it a challenging time for active managers and dart-throwers alike.

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