The rise of value-driven equity markets, getting offensive and what REIT investors shouldn’t ignore

The U.S. earnings season is more than half completed, and the results have been nothing but bullish. Perhap,s more importantly, a distinct change in the market’s reaction to positive profit news could signal a sea change for investors.

So far, 315 S&P 500 companies have reported earnings with overall sales growth of 5.6 per cent and a 10.2 per cent year- over-year improvement in profits. Fully 73 per cent of companies have exceeded analyst estimates, which is well over the five-year average.

Merrill Lynch quantitative strategist Savita Subramanian has noticed that stock prices are not benefiting from the positive results, as Business Insider details, “For the first time in 17 years, there are no short-term rewards for topping earnings forecasts … companies that beat on earnings per share and sales have traded in line with the market the next day and over the following five,” Mr. Subramanian said in a note on Monday.

The momentum investing style – based on the premise that the companies with rising stock prices and profits will go on being the companies with rising stock prices and profits, without regard to valuation levels  – has generated the strongest returns in the past five years.  It is a basic tenet of momentum investors that stocks reporting earnings ‘beats’ will see rising stock prices, and yet this no longer seems to be the case.

I can think of two reasons why strong growth is not being rewarded. The pessimistic slant – one I’m not inclined to buy at this point – is that investors believe the party’s over and profit growth has peaked and is set to roll over.

The second explanation is that we’re entering a market favouring value investors. Value-oriented stock selection methods work best in market environments where there’s low profit dispersion – more companies are growing earnings at more or less the same rate. In these situations, the most-attractively valued stock should outperform.

I’m speculating here, but one of the reasons estimate-beating stocks aren’t rising is that more investors are now ignoring momentum factors and focusing on valuations as earnings growth broadens out through the index.

Value-driven equity markets are much less stressful for investors, particularly the risk-averse. Unlike momentum rallies – when everybody’s forced to consider adding companies like at 250 times trailing earnings to keep up with the benchmark  – in value markets prudent investors can buy cheap stocks with downside protection and reap the rewards. For this reason, while I’m not certain a value market is underway, I’m hoping one is on the horizon.

— Scott Barlow is The Globe’s in-house market strategist

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Stocks to ponder

Exchange Income Corp. The stock has been under pressure this month as short-sellers questioned the monthly dividend’s sustainability. Insiders are taking the other side of the trade. Ted Dixon explains.

Home Capital Group Inc. The company reports second-quarter results after markets close on Wednesday, with a conference call on Thursday. It will be the first earnings report since U.S. investor Warren Buffett bailed out the company in June, and the first chance for new Chief Executive Officer Yousry Bissada to lay out the company’s plans. Here’s a preview.

General Motors Co. Investors are shunning auto stocks because of a cornucopia of worries related to technological disruption, emissions issues, an over-reliance on leasing and slowing U.S. sales. There now may be hidden value.

Equitable Group Inc. The lending company has seen downside pressure and volatility in its shares as investors question the strength of Canada’s housing market and economy. John Reese looks at three underperforming stocks worth considering.

The Rundown

The case for cyclical stocks: Why it’s time for investors to play offence
A rising Canadian dollar, strength in multinational industrial stocks and base metals prices combine with manufacturing data to highlight an accelerating global economy. The weight of evidence is compelling and investors should tilt their portfolios toward economically sensitive growth stocks, rather than defensive equities, for as long as the trend holds. Scott Barlow explains.

A four-letter word every REIT investor should know
Investors who are fans of REITs are likely familiar with another acronym, AFFO.  The problem, however, has been that there was no precise definition for AFFO, much like there’s no standard definition for “adjusted EBITDA,” a metric that can give investors fits. David Milstead examines the implications.

Five simple ways to de-stress your investing plan
What if you’re not into understanding a lot of esoteric investing terminology? What if all you want to do is make your investing plan as simple and straightforward as possible, while minimizing the need for extra record-keeping and paperwork at tax time? John Heinzl has developed a five-step program just for you.


Rob Carrick: Enough with the cliché of the poor senior on a fixed income

Financial facelift: Suburban Toronto couple look to get their savings back on track

How to make a success of succession when passing on the family business


Number Crunchers

Six quality TSX small-caps that may have slipped under your radar


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