FINANCIAL MARKET UPDATE 10.12.2021

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

WHAT INVESTORS CAN LEARN FROM SPORTS BETTING

A major criticism that active stock-pickers levy against a broadly diversified approach is something I’ll call the ‘no losers rule.’ Proponents of active stock-picking contend that if you are fully diversified, you are forced to own all companies, including the unattractive ones. Through their careful analysis, these managers claim the ability to improve returns, in part, by identifying and excluding those bad companies. Admittedly, this argument appears to be extremely compelling. Unfortunately, this claim ignores some key features of the stock market, which essentially eliminates its usefulness.

To understand why this is the case, let’s consider the example of college football betting. Each week there are dozens of games where an avid football fan could confidently predict the winner. There are usually even a handful of games where a casual fan could do so. Let’s look at an example. In early September, the Alabama Crimson Tide hosted the Mercer Bears. Anyone with a pulse knew Alabama was going to win that game. If you wanted to bet on Alabama to win with even odds, you would have had a tough time finding someone to take the other side. To encourage gamblers to bet against the favorite, the sportsbooks can adjust the odds. Through this process, the favorite is handicapped to the point where the expected payoff is roughly even regardless of which team the bettor selects.

There are a variety of ways to handicap a matchup, including the use of a point spread. The spread was set at 54 points for the Mercer vs. Alabama game. For a bettor to make money on Alabama, they didn’t just have to win; they had to win by more than 54 points. That’s a high hurdle to clear, even for a team like Alabama.

Source: Covers.com

While Alabama was the obvious choice in a straight-up contest, simply knowing which team was better was not enough to help you make money. The betting markets updated the odds and, therefore, the expected payoff of the decision. The clearly superior Alabama program won the game but did not cover the spread, losing money for anyone that went with the favorite.

The stock market is loaded with Mercer Bears. These companies are nowhere near as good as the Crimson Tides of the business world (Apple, Amazon, Google, etc.). They might be slower growing, less profitable, less scalable, and/or more capital intensive. Frankly, you’ve probably never even heard of them. That does not mean these ‘losers’ are bad investments, however. Like the sportsbooks in Vegas, the stock market is an incredibly efficient handicapping mechanism. Through changes in price, the market can ensure every company appears to offer a reasonable return on equity given their degree of exposure to a variety of risk factors.

Investors bid up the price of popular stocks. In doing so, the bar is raised on the results those companies must deliver in order to justify their price. Similarly, as investors shun the ‘losers,’ their price can fall to the point where even mediocre results can lead to a stellar return. An active stock picker cannot hope to achieve superior results by simply identifying the best and worst companies for the same reason a bettor won’t win simply by knowing who the best and worst teams are. What matters are the spreads on the games and the prices of the stocks. Neither is likely to be exactly right, but they do represent the best possible estimates at any point in time.

WEEK IN REVIEW

  • Last Friday, the Bureau of Labor Statistics published its updated jobs report for the month of September. For the second month in a row, the number of new jobs added in the economy disappointed. Nonfarm payrolls increased by 194k vs. expectations of 500k. The figure was held lower by a 123k decrease in government jobs, mostly attributable to public schools. The unemployment rate fell to 4.8% from 5.2%, reflecting a combination of the payroll increase as well as people dropping out of the labor force.
  • Earnings season is slated to kick off this week for S&P 500 companies. After nearly doubling on a YoY basis last quarter, investors will be looking for continued growth to justify elevated equity market valuations. According to the WSJ, analysts are expecting a 28% growth rate for the 3rd quarter. Investors will be paying close attention to the degree that rising input costs and supply chain bottlenecks are pressuring margins.
  • Notable data to be published this week includes inflation data and the minutes from the last FOMC meeting on Wednesday, jobless claims and producer prices Thursday, and finally retail sales, consumer sentiment, and business inventories on Friday.

ECONOMIC CALENDAR

Source: MarketWatch

HOT READS

Markets

  • September’s Jobs Creation Comes Up Short With Gain of Just 194,000 (CNBC)
  • A Record 4.3 Million Workers Quit Their Jobs in August, Led by Food and Retail Industries (CNBC)
  • IMF Cuts Global Growth Forecast Amid Supply-Chian Disruptions, Pandemic Pressures (WSJ)

Investing

  • Two Stories From Nature That Teach Us a Few Things About Investing (Morgan Housel)
  • An SEC Rule Was Meant to Protect Individual Investors. Chaos Ensued. (WSJ)
  • Reading the Tea Leaves Why Technical analysis is dumb (Jonathan Clements)

Other

  • A Huge Subterranean ‘Tree’ Is Moving Magma to Earth’s Surface (Wired)
  • How to Remember What you Read (Farnam Street)
  • 1 Billion TikTok Users Understand What Congress Doesn’t (The Atlantic)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

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JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 12+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. He is also responsible for portfolio trading, research and thought leadership as well as analytics and operational efficiency for the Firm's Financial division. He lives in Omaha, NE.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

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