What Makes a 'Perfect' Stock
Joel Litman on the 'perfect' stocks to own... Continuing yesterday's discussion... What rate cuts would likely mean for stocks... Be careful what you wish for... Valuation matters... A warning for the 'Magnificent Seven'...
He has us convinced...
Joel Litman – founder of our corporate affiliate Altimetry – has a proven system for picking winning stocks... and avoiding losers.
During his brand-new video presentation last night, Joel explained all the details about how he goes about his "forensic accounting" work to discover the true earning power of a business. His analysis goes far beyond the conventional metrics that Wall Street has used for decades.
If nothing else, it was worth watching last night's free event for this information alone. You can watch a replay here.
I (Corey McLaughlin) know things like "non-GAAP" accounting might not sound like sexy topics... but presented in the way Joel did, it's worth the listen.
It's part of the way to find "perfect stocks" for what he thinks will be a rocky period in the markets ahead. As Joel – who, remember, consults with Wall Street clients, the FBI, and the Pentagon – says in the presentation...
At the end of the day, you don't have to understand a lick of accounting to benefit from what I do.
You just need to understand that these distortions exist – and they can make you a lot of money.
The proof is in our track record.
He went on to describe multiple single-stock returns of more than 2,000% or nearly 1,000% on the casual shoemaker Crocs (CROX) during the pandemic... and how his Altimeter system "detected a 7x earnings distortion" in tech giant Apple (AAPL) way back in 2010. As he said...
Can you imagine knowing to buy Apple well over a decade ago? You would have been along for an extraordinary 2,500% ride.
And he shared another welcome surprise...
Combined with another powerful stock analysis system, Marc Chaikin's Power Gauge, Joel explained that you could have identified a select number of stocks – 164 – over more than a decade that would have met both Joel and Marc's definition of "turning perfect" and delivered the type of returns Joel was describing.
On average, these stocks returned four times the S&P 500 Index...
Plus, not only would following this strategy get you into the right stocks at the right time, but it would also keep you out of the wrong stocks. As Joel says, this is an important thing to think about all the time... but especially now, as his analysis is warning of a recession next year.
Yet Joel also said that even if a recession hits, you can't afford to be out of stocks. He shared a stunning chart showing the difference in returns if you hold stocks through a recession versus trying to avoid them or staying completely out of the market in cash.
But he strongly recommends you own the "perfect" stocks to protect and grow your wealth. Click here for all the details now, to find out what makes for one of these stocks... Just for tuning in, you'll also hear four free recommendations – two buys and two sells.
Now, picking up where we left off yesterday...
In yesterday's edition, we made the case that the Federal Reserve could potentially cut its benchmark lending rate in early 2024... primarily because of what we're seeing from a weakening job market and a pace of inflation that has continued to ease.
This is not guaranteed to happen, of course. Maybe the economy will hold up throughout next year like it did this year and the "Fed pause" will continue. (If that's the case, history suggests stocks are likely to keep trending higher.)
But a scenario in which the Fed is compelled to cut its lending rate – which would ripple on to banks and on through the economy – is worth at least considering as we think about the year ahead and how to position a portfolio today.
As we'll explain, it's another reason to be careful in 2024.
With inflation easing and cracks starting to show in the jobs market, the Fed could be inclined to juice the economy in the next few months and year ahead. And even if this hypothesis is wrong, it's what more and more investors are betting on right now. That's the reality that we need to live in.
As we wrote yesterday, the bond market is signaling this expectation starting in early 2024.
So, what do rate cuts typically mean for stocks?...
A common perception is that rate cuts are good for stock prices in general. As I wrote yesterday...
Conventional Wall Street wisdom says as much. After all, as we've said before, quoting Warren Buffett, "Interest rates are to asset prices... like gravity is to the apple. They power everything in the economic universe."
But as we also said, there is a different truth in the details. Every major financial-news outlet has published coverage of "stocks rising on the hope of Fed rate cuts." But here's our caveat...
That is true and timeless advice over the long run. In the shorter run, though, if the Fed sees a need to cut rates, that means the economy, businesses, and everyday people are hurting financially – whether it's called an "official" recession or not.
This is an important point that you don't hear nearly enough but is critically important to understand.
Here's a relevant example, shared by QI Research CEO and chief strategist and former Fed employee Danielle DiMartino Booth, who presented at our annual Stansberry Conference in October...
The Fed won't cut rates when everything is going well for the economy...
It will cut rates, or start sending messages about possibly cutting rates, when things are going wrong. At that point, sell-offs in the broad stock market may have already started.
Stock prices, generally, are likely to fall as the economic trouble builds and growth expectations fall – for whatever reasons – ahead of any Fed rate cuts. Plus, as history shows, losses may continue for a while even after the Fed starts cutting rates.
In the past 50 years, after the Fed has started a rate-cutting cycle, the S&P 500 has dropped by an average of 20% after the bank's first cut before hitting a low, according to data from Bloomberg and global institutional brokerage and advisory firm Strategas Research.
The most recent example was in March 2020. After the central bank announced an "emergency" rate cut to near zero on March 3 as "novel coronavirus" panic began to grip the market, stocks fell 25% and didn't bottom until March 23.
Only after the Fed did more, including making massive bond purchases and even buying equities, and after Congress decided to mail debit cards and checks directly to Americans, did the market start to sharply rebound.
Then came the inflation and... where we are today.
A mixed bag – depending on the circumstances...
Let's take a closer look at the history of market moves before and after the Fed starts cutting rates...
Some sell-offs ahead of the first rate cut have been relatively short, like in March 2020, when it seemed like much of a business cycle was condensed into one month. A 100-basis-point rate cut in the weeks after the crash in October 1987 similarly stabilized the markets.
But other rate-cut decisions happened amid or at the start of much deeper and longer drawdowns...
In the high-inflation 1970s, the Fed started to cut rates in mid-1974. Stocks eventually started to turn around into 1975, but not before the S&P 500 had dropped 50% from a previous high in 1972 – including 28% after the first rate cut.
Other rate-cutting periods – in 2001 to 2002 after the dot-com bubble burst... in 2007 to 2009 amid the financial crisis... in 1981 to 1982... and in 1989 to 1990 – lasted much longer, averaging 17 months, and were typically deeper.
The better news? Nearly half of the S&P 500's nine declines after a first rate cut were mild, in the single digits (and were followed by strong, double-digit six-month returns).
But the other five sell-offs were more than 20%, as much as 55% and 42% after the dot-com bubble and in the financial crisis, respectively. And stocks were still down six months after the rate cut.
This is why I wanted to bring the subject up today. We will keep watching for indications that the Fed is planning on cutting rates and the data that might cause it to do so (like unemployment).
But the main point is, don't be caught off guard by a sell-off before or after the Fed may cut rates.
Now, this doesn't mean that all stocks will behave the same way. Certain businesses – like banks and energy companies – tend to do better early in rate-cut periods, for instance. It will be a challenging environment for many stocks, but also a potential great buying opportunity in some others.
One factor makes the most difference in performance...
Valuations.
According to an analysis by Meeder Investment Management...
When the market had a decline of at least -20% after the Fed's first cut, the average S&P 500 trailing [price-to-earnings (P/E)] ratio was 18. On the other hand, when the S&P 500 had a decline of less than -10%, the average [P/E] ratio was 11.4.
Today, the S&P 500 trailing-12-month P/E ratio is 21. This suggests that if we were to see a drawdown after a Fed rate cut, it's likelier to be strong than mild. Though we also know the U.S. benchmark index's performance and valuation is skewed higher by the influence of the "Magnificent Seven."
These leading tech stocks may be due for more of a hit than any others.
(To this point, on next week's Stansberry Investor Hour, Dan Ferris and I speak with our colleague Whitney Tilson. We recorded the interview yesterday and, sneak peek, Whitney said he'd be most concerned about shares of Nvidia (NVDA) and Tesla (TSLA) in the event of a broad market sell-off, given their extreme valuations.)
We can't know for sure what will happen next. History isn't guaranteed to repeat. But if we do see rate cuts, they probably won't provide an instant "fix" to any market performance amid heightened economic uncertainty in the short term.
In the long term, yes, rate cuts have historically boosted stocks. But the market has headed lower first to varying degrees. So anyone begging for cuts today and banking on the elusive Fed "pivot" to instantly push the market higher should be careful what they wish for – and be prepared for the opposite instead.
New 52-week highs (as of 12/6/23): A.O. Smith (AOS), Costco Wholesale (COST), D.R. Horton (DHI), Enstar (ESGR), Fidelity National Financial (FNF), Huntington Ingalls Industries (HII), Lennar (LEN), PulteGroup (PHM), SentinelOne (S), Sprouts Farmers Market (SFM), Sherwin-Williams (SHW), Stellantis (STLA), and Trane Technologies (TT).
In today's mailbag, we received some questions about if there will be a replay available of Altimetry founder Joel Litman's event last night. As we covered to start with today, yes. You can watch this free event at your convenience here.
All the best,
Corey McLaughlin
Baltimore, Maryland
December 7, 2023