Attending the Exchange conference in Miami last week, VettaFi had the chance to catch up with Lisa Kirschner, head of research at Richard Bernstein Advisors. Below is the discussion with writer Nick Peters-Golden focusing on RBA’s understanding of the profits cycle and the key trio of profits, sentiment, and liquidity.
Nick Peters-Golden: I would love to hear a little more about RBA’s research in the profit cycle. How can you tell in the earnings how it’s accelerating in one direction or another?
Lisa Kirschner: As we start to assess opportunities, first, we’re going to look at countries and sectors worldwide. We’re going to run a quant model behind the scenes just to see where everything sits. And that sets up a framework, a very disciplined framework, and we’ll look at that through an earnings growth lens. We’ll look at earnings growth and growth momentum, we’ll look at price momentum. We’ll look at valuation metrics and throw a bunch of math in there to make it kind of sexy and fun. And then we’ll come up with some scores. And then we’ll look and see, “How does everything align?”
And you know, talking about it in the meeting yesterday, we’re frequently looking to find, “Where do you have a dichotomy between your growth and your valuations or sentiment piece?” That’ll give us some information there. There might be a bunch of stuff that looks like, “Hey, look, this is growing, this is growing, this is growing. But hey, this whole batch is expensive. And look, these guys are growing, but they’re not so expensive.” So that might be an opportunity or a lack of an opportunity in other cases, and then you’ve got all the ones where they’re not grown at all. So that’ll just set a framework.
Peters-Golden: And so how does that then apply to foreign markets?
Kirschner: In terms of knowing whether the profit cycles are going to accelerate or decelerate, we build profit forecasting models for all the major countries. Starting in the U.S., now that’s grown out with a long history, Matt Poterba, who’s been working with me for about seven years now, has created and grown a lot of our non-U.S. work. So now we’ve got U.S., Europe, China, we’ve got six or seven different regions, basically major regions, EMs we have broken out into LATAM/EM Asia/EMEA because they’re different parts of the world, so we want to have those split out a bit. And again, some major countries that we have a specific interest in, so we also have China, Canada, Japan, and Brazil. So we look at all these, and what we do is we try to find leading indicators for these forecasting models.
But for us, one of the most important things to think about is that you don’t want to hang an acceleration or deceleration in your work on one indicator. This is important, everybody loves PMI. Okay, fine, but it’s one indicator, it can be wrong. And sure, a bevy of indicators can be wrong too, but what we do is we try to find a grouping that makes economic sense. Are we picking up the drivers of profitability, production, pricing power, and margins?
If we can find those pieces and see, “Where can we get some lead there? Where can we get some information?” For us, since we’re looking for inflection points, we’re looking to find something one to two quarters in advance. You’re not going to generally get a year in advance for the inflection point.
So we look at these, and we build these models to give us those signals, and we run those monthly, so the quantitative pieces are those profits models themselves. And then the qualitative piece is, you’ve got to make the judgment call in the assessment of the model. When do you have a strong enough signal to? You saw a little wiggle that could just be noise, so we looked for a bit of persistence. You see that continuing, you double-check which indicators are shifting. Is there something behind the scenes that might be causing a misconstruction? The discipline is in following the indicators and looking at them very carefully to ensure that we can really pinpoint the upcoming inflection point.
Peters-Golden: That’s great! What kind of other information are you taking on in looking at the profit cycle?
Kirschner: Outside of our formal models, we have a whole bunch of additional indicators we’re looking at, again, just with that sort of idea in mind. Are we seeing the correct picture? Does this make sense? If there’s something that doesn’t make sense, let’s dig into that. Don’t just assume, “Oh, it’s different this time,” go dig into it and find out why this is doing this. Is there something going on underneath, or does it make sense? We’re not going to ignore it if it’s giving us a signal, we’re not going to ignore it because it maybe doesn’t make intuitive sense. But we’re going to assess it and dig into it, and maybe we’re going to take our time a little bit with it and say, “Let’s give that another month because this seems a little funky.” And that’s the art side of those indicators.
Peters-Golden: That was such a clear explanation, really detailed. I feel like sometimes people just say, “We just do our analysis,” and they leave it at that, so I appreciate the detail.
Kirschner: So those are the pieces. In every region of the world, we will have similar, but not identical, indicators. Different countries and regions may be better correlated to differing indicators. So we spend a ton of time examining their correlations to the profit cycle itself and look at rolling correlations through time. Of course, they’re not always going to be as consistent again, that kind of goes to why you want more than one, right? Something may be highly correlated in one cycle and completely uncorrelated in another, so you get much less of a signal. But we use those correlations as a way again of assessing and judging the efficacy of each individual indicator in the model and making sure the model is working as it should.
Peters-Golden: So, I’m curious. There’s obviously a lot of positive indicators, you’re looking at things that would suggest an upswing. What kind of indicators do you look for that might indicate risks, like indicators of a commodity price crash, for example?
Kirschner: Many risks will fall into the liquidity picture, and the profits world, too, if we’re forecasting a profits recession, which is clearly a negative. Which we are actually forecasting this year in most regions.
Peters-Golden: So there you go! I guess I’m curious, having just come from a talk on geopolitics, does the RBA model account for things like political vents, risks that would be extraneous?
Kirschner: We do not specifically incorporate geopolitical risks into our work. Again, we’re not event-driven, but that doesn’t mean we’re not paying attention to what’s going on [in] the global political stage. It’s very, very important. Geopolitical events can take many years to play out. But then, of course, you could have a war, but we’re not going to be able to forecast that. So that’s event-driven, and we’re going to see if something occurs, we’re going to see how it flows into the data in our indicators — and it will. And it’ll flow pretty quickly. It’s not going to take that long — when COVID happened and the economy shut down, our indicators all turned pretty much instantly.
Peters-Golden: Is there anything about the RBA model that you would love people to understand a little more?
Kirschner: We try very, very hard to be agnostic and let the data tell us what’s going on and not prejudge. And I think that it’s very important to look at the longest histories that we can look at. It’s critical to look at many cycles and see where there are similarities and dissimilarities.
I think, for me, it comes back to the fact that investing needs to be disciplined. And it needs to be based on a clear understanding of those three pillars: profit, sentiment, and liquidity. Everyone may not look at them the way we look at them. Everybody’s got their own twist on it. But those are the three core pieces that give you investing knowledge. You need to pay attention to those and ignore the hype that’s out there that causes mispricings.
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