VD 111: The Stock Market: Still a Leading Indicator?
In this issue:
The Stock Market: Still a Leading Indicator?
Stock in focus: EVS Broadcast Equipment
The Rationality Test: ASML
What I’ve been reading these past few weeks
News from our companies
Doubler Portfolio update
The Stock Market: Still a Leading Indicator?
When I started investing back in the last century, the common wisdom was that the stock market leads the real economy by about six to nine months. If the market corrected or crashed, it meant the real economy would face a significant slowdown or even a recession anywhere from a few months to a year later.
Today, we are witnessing two wars with a significant financial impact on the global economy, yet the market seems unfazed. I find it particularly strange that investors appear to dismiss the reduced supply of oil and gas as a mere footnote. Despite widespread electrification, high oil prices—especially if they persist—remain incredibly damaging to the economy.
In Europe, we’ve already felt the sting of high energy costs after we stopped importing cheap Russian gas. That gas didn’t disappear; it just flowed to other customers. Now, we are seeing oil face logistical hurdles.
The fact that markets are reacting so lukewarmly to these developments, seemingly more preoccupied with Trump’s latest tweets, genuinely concerns me. Is the market underestimating the impact? Or am I being too pessimistic, and will these conflicts resolve quickly? Hardly anyone believes a ceasefire will hold, so it’s bizarre that the market isn’t pricing in the risk.
Does the market truly believe in a swift resolution regarding the conflict in Iran? Or are there other forces at play keeping the floor under these prices?
Since the Covid crash, investors seem to have been conditioned to “buy the dip” at every opportunity. Every decline was viewed as a buying window, and people jumped in en masse—and they were rewarded for it. It has become a Pavlovian response.
This time, however, feels different. While there are still conflicting reports of heavy buying on down days, we are starting to see the first signs that retail investors are pulling back and becoming more cautious. “Buying the dip” becomes a lot harder to justify when prices stop rebounding despite all that capital flowing in.
Alongside the dip-buyers, passive investors are another reason the market isn’t dropping yet. they keep buying regardless of the red flags. They stick to their systems, sometimes out of conviction, and sometimes simply because their pension contributions are automated.
I’ve written this before: I won’t believe in a true, heavy correction or crash until we see US employment numbers drop and that vicious cycle is broken. In essence, this means I no longer view the stock market as a leading indicator. I believe the economy will have to slow down sharply first before we see the market correct in proportion.
There isn’t definitive proof for my theory yet, but we might soon find out if the market retains its predictive power or if my thesis holds water. Currently, the US labor market remains strong, but the first signs of a cooldown are appearing. Very expensive oil will have global consequences, significantly increasing the odds of a slowdown or recession.
Does this mean we should exit the market and wait on the sidelines? Of course not. However, I am looking differently at things like non-essential consumer goods, as those are the first things people cut back on. I certainly wouldn’t pay a premium for growth in that sector right now.
I mostly see this as an opportunity. Our smaller companies were already cheap, and since they aren’t part of the major indices, I don’t expect them to be sold off as aggressively when pressure builds. They are also resilient enough to weather a storm. On the flip side, we have the cash ready to capitalize on the opportunities the market hands us.
Small-Cap Value ETFs: Just Junk?
Finally, I want to address something I was asked several times at the VFB Happening. My focus is heavily on small and mid-sized companies using a value investing approach. Many investors find this too labor-intensive and prefer buying an ETF that targets these factors.
By now, you probably suspect I’m not the biggest fan of passive investing, even though I think the concept is sound for the average investor. The problem is that it has evolved into a dogma, leading to a lack of common sense. With a World ETF, you can at least argue you’re investing in today’s winners; the biggest companies are usually the biggest for a reason.
However, when you apply value factors to smaller companies through an ETF, you are essentially buying about 80% junk. This is partly because value factors are often too narrow, but also because this pool includes yesterday’s losers. Some will indeed be small, growing firms or turnaround stories, but a large portion is the “garbage” that value investing is often—unfairly—associated with.
In that scenario, you’re playing a losing game. The companies that actually perform well within those ETFs end up being kicked out because they grow too large or no longer fit the “value” criteria. In other words: you sell your winners and replace them with the losers falling out of the large indices.
Small-cap, mid-cap, and value are true stock-picker markets. That is where you make a difference with your own analysis and by looking further than the rest. Or, as Howard Marks puts it: “What we do is take advantage of the mistakes of others. We want to get returns that are more than commensurate with risk. And to do that, you have to buy assets not at fair prices, but at unfair prices.”
I am simultaneously very excited about the opportunities available now—which may become even greater in our segment—and naturally anxious about what war will do to the economy. We have no control over the latter; however, we do have control over our constant search for opportunities and the smart deployment of our cash.
