Today we’ll outline Morgan Stanley’s view that the top-performing equity market strategies over the past 18 months will continue to outdistance broad indices, look at the characteristics that make an honest market strategist, and express my annoyance with academic economics.
A view shows Ozempic pens, as they are assembled at the Novo Nordisk facility in Bagsvaerd, on the outskirts of Copenhagen, Denmark.Tom Little/Reuters
Obesity, AI and Defence stocks have further to climb
I finally got to an end-of-August Morgan Stanley research report bravely entitled What to Buy and Sell and I’m very glad I did. The main takeaway from equity strategist Edward Stanley’s analysis is that investors should not give up on the three biggest outperforming market themes of the past 18 months: obesity, artificial intelligence and defence.
The obesity theme is dominated by drugmakers Eli Lilly and Company (LLY-N) and Novo Nordisk A/S (NONOF) where diabetes treatments were developed that just happened to work as long-term appetite suppressants. (Interestingly, the drugs also appear to curb alcohol, opiate and nicotine addiction).
Eli Lilly stock is up an impressive 189.4 per cent in the past 18 months and Novo Nordisk is not too far behind at 88.1 per cent (that’s the U.S.-traded ADR). Despite the ramp higher, the obesity theme still has the best combination of sales and EBITDA growth of any investable theme Morgan Stanley follows.
Mr. Stanley groups robotics companies along with the common AI names. So far this year, profit forecasts for the theme overall have been revised higher by 10 per cent while valuations have climbed by 15 per cent. The analyst writes that “this is not typical of a frothy theme,” which would have low revenue and much more expensive valuations than the current EV/EBITDA of 21.
The defence theme received the least amount of explication by Mr. Stanley, who merely noted that upward earnings revisions more than justified current valuations. I can add that the S&P 500 Aerospace and Defense index was up a decent 24.5 per cent – Boeing was unhelpful – over the past 18 months. Mr. Stanley, however, seemed more interested in European defence stocks BAE Systems PLC (up 45.8 per cent for 18 months) and Germany’s Rheinmetall AG (up 107.3 per cent).
Mr. Stanley included a list of 50 stocks with exposure to the biggest number of the 36 broad market themes he covers. This list has outperformed the S&P 500 by a factor of four over the past decade on a market cap-weighted basis.
The usual suspects are present among the 50 – Nvidia Corp., Microsoft Corp., Apple Inc. – and they’re joined by Visa Inc., Advanced Micro Devices Inc., Roche Holding Ltd., Gilead Sciences Inc., Moderna Inc., and Oracle Corp. in the top half of the list. Other names with exposure to a smaller number of themes that might nonetheless interest Canadian investors include Palo Alto Networks Inc., Cisco Systems Inc., Enphase Energy Inc., and Paypal Holdings Inc.
How to find an honest strategist
Callie Cox, the self-titled chief market nerd at Ritholtz Wealth Management (she’s actually chief market strategist) laid out some ground rules for people in her line of business in Some thoughts on intellectual honesty. The rules also provide investors with a template for identifying strategist frauds.
Ms. Cox said these are the attributes of the best strategists:
- Talk about different scenarios, not in absolutes
- Stay intellectually true to vetted series of hard, high-fidelity data
- Focus intentionally what makes the economy and markets tick
- Make their thought processes public
- Disclose their timeframes – or in other words talk about if their beliefs hold true for the weeks, months and years ahead
- Address the counterpoints to their argument
- Regularly say “I don’t know”
- Talk in plain English without wrapping their analysis in vague phrases (“cautiously optimistic”)
- Don’t tell you what to buy or sell, but how to think about what’s going on
The first rule appeals to me as someone who usually thinks about markets in terms of ‘If, Then’. If, for instance, U.S. economic growth accelerates significantly, then low valuation stocks should outperform and the equal weighted S&P 500 will outperform the conventional cap-weighted index.
Rules two and three summarize why I hate single line charts. Virtually every chart I publish will feature an asset price and a market driver, showing a potential connection that will affect investor portfolios. Industrial metal prices, for example, are highly correlated to global manufacturing activity as measured by the J.P. Morgan Global Manufacturing PMI index.
Announcing time frames is hard, I probably need to work on that. We are smartphone-addled monkeys with no attention span at this point but economies and markets move at their own pace, over months and years. Was the pandemic era inflation transitory? It depends on the time frame you’re thinking of at the moment.
The last rule may be frustrating for readers who just want the final answer - lucrative investors. In more unguarded moments I respond to this sentiment with “If I knew with certainty what an asset price will do I’d live in Connecticut in a house the size of an airport and commute to work by helicopter.”
Diversions
Why I don’t argue economics anymore
The Atlantic recently featured a new paper highlighting the dismal state of economics prizes. The study, by Harvard University’s Richard Freeman, Tsinghua University’s Danxia Xie and Hanzhang Zhou and Michigan State’s Hanzhe Zhang, found a highly suspicious degree of favouritism amongst economics prize winners, including the Nobel.
The analysis found that any academic economist aspiring to any major award has to spend half of their career at one of eight universities – Harvard, Yale, Princeton, Stanford, M.I.T., Chicago, Columbia or Berkeley. No one else has won an award.
The study also found that award winners in the hard sciences study in a much more diverse group of institutions. The Atlantic column, by Harvard professor David Deming ironically, notes that the 2019 Nobel Prize in chemistry was shared by scholars at the University of Texas, SUNY Binghamton and Japan’s 108th ranked university, Meijo.
Mr. Deming gets to the heart of the matter in writing, “an idea’s merit is tied much more to its practical implications than to the perceived brilliance of the author.”
It is telling that even experts have trouble identifying value in economic research and merely defer to the logical fallacy of appeal to authority. Prominent papers (besides this one of course) increasingly focus on esoteric math with little or no applications in the real world. The failure of widely-used DSGE models ahead of the financial crisis was unforgiveable.
This issue highlights why I rarely get involved in debates about economic theory. It’s almost impossible to tell who wins.
The essentials
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Globe Investor Highlights
Warning signs are flashing that the biggest risk for markets and policy makers is not “higher-for-longer” inflation, but the virtual disappearance of price pressures. On a related note, it’s bonds, not equities, now doing the heavy lifting in 60/40 portfolios.
CIBC economist Benjamin Tal has a good recent track record of predicting monetary policy. He’s now revising his forecasts for just how low the Bank of Canada will ultimately cut rates. And he has some new thoughts on the housing market, too.
After two terrible years, REIT prices are soaring on the TSX. Tim Kiladze takes a look at whether the rally is sustainable.
Rosenberg Research analyst Bhawana Chhabra argues that, at least for longer-term investors, the recent dip in commodity prices presents an attractive buying opportunity.
What’s up next
The calendar for data is light on both sides of the border for the rest of the week. U.S. Producer Prices on Thursday – 0.2 per cent month over month ex-food and energy is expected – is pretty much all that matters for most investors.
Next week is busier. Domestic manufacturing sales for July will be reported Monday with 0.3 per cent year over year growth predicted. Existing home sales is also out Monday but Bloomberg doesn’t collect economists’ guesses on that one.
Tuesday is Canadian CPI, an important number. 2.1 per cent year over year is expected. The Americans have retail sales ex-autos for August on Tuesday, with a rise of 0.3 per cent month over month expected. U.S. industrial production is also out Tuesday, anticipated to be up 0.1 per cent month over month.
See our full economic and earnings calendar here (You can bookmark the page - it gets updated weekly)