DIARY OF A PORTFOLIO MANAGER

February 23, 2024

“All I ever wanted
All I ever needed
Is here in my arms
Words are very unnecessary
They can only do harm”

Enjoy the Silence – Depeche Mode

Good day,

I’ve often said (and written) that what really matters over the long term is earnings. Everything else is noise. Unfortunately, the media needs to fill up each day with 24 hours of ‘something’ and earnings come out only four times a year. Sensationalism sells. At the end of the day, there is only so much to say on a given topic. There is a lot of noise out there.

2024 So Far

Global equity markets have maintained their strong start to the year. This is despite investors needing to recalibrate their expectations for the timing of interest rate cuts (sounds more in line now with what I suggested all along). Recent global economic data has been mixed, whereas in the U.S. it has largely exceeded expectations. The latest inflation reading suggesting a modest uptick in price pressures (a lot of this is housing which doesn’t affect as many people as you would think). Meanwhile, minutes from the U.S. central bank’s recent meeting revealed that policymakers continue to ponder the risks associated with premature rate reductions.

Earnings Season Winding Up

A key factor behind the equity market's strength lately has been earnings results. Fourth quarter U.S. earnings are set to rise by just over 3% year-over-year, roughly double the expected pace. Though not remarkable in absolute terms, this growth is notable given the anticipated drag from higher interest rates on operating profits. Earnings results were especially strong across some pockets of the Consumer, Industrials, and Technology sectors. The “Magnificent Seven” technology-centric stocks, which make up nearly 30% of the U.S. S&P 500 index, have been crucial to driving the market’s overall earnings growth due to their sheer size and influence. Without their contribution, earnings growth would have declined by 4% year-over-year. In other words, while the U.S. market’s earnings growth looked fine relative to expectations, the strength of its underlying companies may be overstated given the lack of breadth.

Management Team Comments

During this earnings season, comments from management teams have been generally positive with respect to consumer demand, although several noted consumers’ growing sensitivity to prices. Nevertheless, many companies highlighted robust economic indicators, such as high job creation and low unemployment claims. In their view, this suggests consumers can continue to spend, albeit with budgets strained by inflation. And while retail sales numbers recently came in below expectations, they remain significantly higher than pre-pandemic levels. Management perspectives varied on operating conditions, with some looking for clearer guidance on interest rates and others voicing concerns over persistent inflationary pressures and cost challenges. Across the board, there was a clear focus on cost management and profit margin improvement.

The rest of 2024

As we look to the rest of 2024, earnings growth is expected to pick up. Analyst estimates suggest an earnings growth rate of nearly 9% for the year which I think is very optimistic. And unlike the past year, this growth is anticipated to be more broadly distributed across various companies, not just the “Magnificent Seven”. This more evenly distributed earnings growth would be a welcome development, but this outlook is predicated on several assumptions:

• consumer and business demand that remain resilient and potentially improve
• a deceleration in inflation
• lower interest rates

While such a scenario is entirely possible, the range of potential near-term outcomes remains wide, given how far interest rates have moved over the past few years and questions regarding inflation’s future trajectory. Many names that we recently started positions in have run up beyond what we expected. This is good because we own some. It’s not good because I want to buy more and feel like I am chasing them in short term. In managing portfolios, I am using greater caution than usual given these uncertainties.

I am putting together some thoughts on Bitcoin and the volatility it adds to a portfolio. First draft is way too technical so I will work on tweaking it a bit.

Have yourself a great weekend,