Market Phase Cycle™ Investing Strategy
The signal and the noise
The title of Nate Silver’s 2012 best selling book about predictive models, The Signal and The Noise, is referencing identifying real signals from statistical data, versus identifying false noise and relationships, and the risk of conflating the two.
The market almost broke to new all-time highs earlier this month. Now the market is seeing increased overall volatility due to concerns about trade and Turkey, and significant individual stock volatility as we work through earnings season. It is worth wondering, which set of datapoints is the signal, and which is the noise?
Looking at sentiment indicator levels before the recent volatility in the market gives a clue to answer this question. As the market approached all-time highs, sentiment had grown very positive, with low correlations, falling short-interest levels, and active investor equity allocations at the higher end of ranges – investors were not expecting any bad news. This caused the recent volatility, investors are being spooked by the noise because they had not been positioned for it.
The real signal remains strong though. The fundamentals of this market remain exceptionally healthy. Thus far, over 90% of the S&P 500 has reported Q2 earnings, and almost 80% have beaten bottom-line estimates. UAFRS-adjusted EPS growth forecasts remains robust, and market valuations are pricing in much slower growth. Also, US corporate balance sheets remain robust. Even in a more volatile macro environment, there is limited risk of a credit shock to offer a catalyst for a major market sell-off.
The market is focusing on the noise, and in this case overstating risks that could cause a sell-off. Investors that focus on the signal of a strong fundamental environment and use this buying opportunity will be rewarded.