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Timing the Market Doesn’t Work. We Did the Math.

Plus, what investors should watch for at COP28 and the outlook for Nvidia stock.

Timing the Market Doesn’t Work — We Did the Math

Ivanna Hampton: Here’s what’s ahead on this week’s Investing Insights. A head-to-head matchup tests whether market-timing works, what Morningstar research shows, and the takeaway for investors. The king of AI chips crushes earnings expectations. Coming up: the outlook for Nvidia as it continues to dominate. And what investors should watch for as world leaders gather for climate change negotiations in Dubai. This is Investing Insights.

Welcome to Investing Insights. I’m your host, Ivanna Hampton. Let’s get started with a look at the Morningstar headlines.

Nvidia’s Outstanding Fiscal Q3 Revenue

Nvidia’s NVDA outstanding fiscal third-quarter results included a more than 200% increase in year-over-year revenue. The king of artificial intelligence chips brought in more than $18 billion in revenue. That blew past Morningstar’s forecast. The chipmaker will likely not give up its dominance in selling chips used in data centers. However, the timing and magnitude of future AI chip growth remains unclear. The U.S. recently restricted chip sales to China. But a significant decline in revenue from China should be offset by robust growth elsewhere in the world. Nvidia’s earnings report suggests it could reach Morningstar’s projection of $100 billion of data center revenue in fiscal 2028. The data center division is estimated to bring in almost half of that this year. Nvidia is predicting $20 billion in revenue in the January quarter. Morningstar maintains Nvidia’s value sits at $480. The stock looks fairly valued.

Cisco’s Gloomy Full-Year Outlook

Cisco Systems CSCO reported impressive fiscal first-quarter results but provided a gloomy full-year outlook. Sales climbed 8% year over year during the quarter, meeting Morningstar’s expectations. And every profit metric exceeded its analyst’s predictions. The networking equipment company benefited from reducing its backlog of high-margin products in fiscal 2023. Despite the strong showing, management has predicted declines. Cisco forecasts a dip in sales in the January quarter from the October quarter and fiscal 2024. Management says its large clients are implementing previously delivered equipment before resuming orders. Fiscal 2024 will likely be a correction year for Cisco. Morningstar has cut its estimate for Cisco’s stock to $53 from $56. However, it still likes the company’s long-term outlook despite current weakness.

Shopping Boosted Walmart’s Q3, but Uncertainty Remains Going Into Holidays

Cost-conscious shoppers boosted Walmart’s WMT third quarter, but their spending is fluctuating heading into the holiday season. Comparable sales grew nearly 5%. Transaction volume drove the uptick. Grocery sales increased, and the category gained market share. Morningstar expects the gains to continue. Health and wellness also delivered strong growth, while demand for general merchandise weakened. Morningstar believes the discount retailer can navigate a slower spending environment and entice shoppers with low prices in categories like grocery. Sales also increased in the company’s Sam’s Club division. Management says membership has reached a record level. Growth in Mexico and China lifted international sales. Morningstar thinks Walmart is worth $147 per share, up from $145.

What Investors Should Pay Attention to at COP28

A milestone check-in will take the temperature on the efforts to limit global warming. World leaders are gathering in Dubai for the United Nations Climate Change Conference known as COP28. So, what should investors pay attention to from this event? Leslie Norton is here to discuss what to watch. She’s the editorial director for sustainability for Morningstar, Inc. Thanks for being here, Leslie.

Leslie Norton: Thanks so much for having me, Ivanna.

Hampton: The 2015 Paris Climate Agreement called for this global check-in to happen this year. What are the storylines you expect to emerge?

Norton: Well, you will definitely see world leaders gather along with climate experts, lobbyists of all stripes, and scientists, and they’re all going to try to forge a consensus in how to address the climate crisis. I guarantee the process is going to seem chaotic. For example, the same day as the opening ceremony for the summit, OPEC has also scheduled a virtual summit, a virtual meeting that will determine what its oil output is going to be for 2024. So, that shows you how chaotic things are going to feel. Let me tell you a little bit about COP28. It’s an annual summit for countries that signed the Paris Agreement, which is every country except for Libya, Iran, and Yemen, and agreed to take action to stop the planet from being warmer than one and a half degrees Celsius hotter than in preindustrial times. So, we’re not near achieving these goals.

What should we expect this time around from this COP? Obviously, a global assessment of progress. One of the things people have been talking about for a while is a fund for developing countries to help them cope with climate change. Another thing is language about phasing out fossil fuels. Now, you might see some foot-dragging around this because the United Arab Emirates, a major oil producer, is actually hosting the talks. And one big thing we might expect is a promise by oil and gas companies to end methane emissions by 2030. Methane emissions are important because they’re 80 times more powerful than carbon dioxide at trapping heat. And the CEO of COP28 says that at least 150 countries and 25 national and international oil companies have signed on to this. So, that’s going to be one sign of progress.

What Are Governments Doing About Rising Global Temperatures?

Hampton: And a recent UN report found that carbon emissions increased last year. It warned that the Earth’s temperature is expected to rise higher than the international target. What are the U.S. and other governments doing?

Norton: Yes, that’s really important. 2023 has been the hottest year on record, and 2024 looks like more of the same, and that’s meaningful for everyone on this planet, including investors. The changing weather raises the risks of flooding, wildfires, rising seas, more frequent hurricanes, and so on. So, how the globe is addressing this is events like COP28 at which we assess our progress. The next set of promises for emissions cuts are due in 2025. Europe is leading in terms of regulation and it has this European Green Deal package of initiatives that will reduce emissions to net zero by 2050. You ask about the U.S., which along with China, the U.S. and China are the two largest polluters in the world. So, the U.S. is committed to achieving net-zero emissions by 2050 at the latest. Let’s talk about 2030. A lot of countries have set 2030 targets so that we’re not leaving this problem until the very last minute. According to Climate Action Tracker, as of 2022, the U.S. has achieved just one third of its 2030 emissions-reduction target. And let’s not forget, 2030 is just seven years away.

The nonprofit expects the U.S. to fall about a third short of meeting its goals in 2030. What are the steps the U.S. has taken? Well, we had the landmark Inflation Reduction Act last year, which promotes clean energy and multiplies demand for things like solar power and electric vehicles. This month, the U.S. agreed with China to tackle global warming. They did this by ramping up wind, solar, and other renewable energy as a way of displacing fossil fuels. The U.S. is upping its game in terms of regulation. The SEC is expected to release its climate disclosure rules, which will make thousands of companies more aware that investors are looking to avoid climate risk and are also looking for climate opportunity. And you are also seeing interesting actions from the states, right? This week you saw Michigan unveil an ambitious clean energy mandate. It requires utilities to be carbon-free by 2040. California has launched an ambitious set of climate disclosure rules. And that’s important because California is the hub for IPOs. So, all of these new companies will start off being aware of climate risk and climate opportunity.

Who’s Leading and Lagging in Becoming Net Zero?

Hampton: And we’re talking about companies. Let’s talk about the push to get them to commit to cutting greenhouse gases and becoming net zero. Can you talk about who’s leading and who’s lagging?

Norton: That’s a great question. It’s safe to say there are few leaders. Susan Zhou wrote Morningstar’s climate transition plan, and she recently wrote about how to understand the climate transition plans of all the companies in your portfolio. You can read about it on Susan called out AT&T T and Taiwan Semiconductor TSM as leaders. Both are committed to reaching net-zero emissions by at least 2050. AT&T has set targets for two common kinds of emissions by 2035, and it’s working with its suppliers to reduce emissions. As an investor, you can check if the companies you’ve invested in have made net-zero pledges and are reporting on their progress in their corporate responsibility reports and their filings. Morningstar Sustainalytics also provides a low carbon transition rating that shows how aligned each company is to a 1.5-degree future. Most companies, I have to say, score poorly on this, but Sustainalytics also ranks managements.

And I’ll tell you what, that’s important. Climate change is the mother of all management challenges. So, a good management score may tell you how the company will address this incredibly complex challenge. And finally, you asked about laggards. Well, Berkshire Hathaway BRK.B is in the news a lot this week. It’s a very, very good company, but according to Lindsey Stewart—and Lindsey Stewart follows corporate stewardship for Morningstar—it is also sort of the target of shareholder proposals around climate risk, meaning it’s gaining a reputation among asset managers as a laggard in addressing climate change. For example, this is what BlackRock says: “Berkshire does not meet our aspirations for disclosing a plan for how their business model will be compatible with a low-carbon economy.”

Investment Opportunities in Clean Energy Transition

Hampton: What does this all mean for investors?

Norton: I’m glad you asked, Ivanna. The road to achieving net zero is going to be a rocky one, but the fundamental premise is still there, that there are endless ways to hedge your climate risk. There are ways to profit from investing in sustainable energy, and there are also many ways to profit from companies that are addressing the carbon transition. More money is going into climate funds than ever. These are funds that focus on low-carbon climate transition, green bonds, clean energy, and there continues to be plenty of solutions to invest in, they will be popularized. According to PWC, a third of the emissions cuts that will occur in 2050 depend on technologies that are only now in development. So, all that’s going to need funding. Now, I know a lot of the clean energy stocks have taken a beating this past year—the wind stocks, the solar stocks. A Bloomberg calculation that I recently saw showed that renewable stocks lost more than $280 billion in market value this past year.

That’s led to the delays of some clean energy projects, and that’s happening at a time that the number and the dollar value of climate-related disasters is rising. So, all this is happening because of rising interest rates and higher inflation, which are hitting demand for things like solar panels, despite the tax incentives from the Inflation Reduction Act. So, you can’t call the bottom right, but, obviously, the bottom is approaching and that’s up to the investor to decide how to average into these investment opportunities. What we have for you at Morningstar is coverage on and about investment opportunities. One is nuclear energy, which is an inevitable part of the transition, so we talked about how to play it. We also looked at the most widely held stocks by climate funds and which of those stocks is highly rated by Morningstar analysts. And Ivanna, lots of people think we’re not going to get to net zero. So, what does that mean for oil and gas stocks? One of the things we do is take a contrarian look at who the beneficiaries might be.

Hampton: All right, Leslie, thank you for your insights today.

Norton: You’re welcome.

Should Investors Focus on Time in the Market?

Hampton: A popular investing saying encourages people to avoid trying to time the market. They should instead focus on time in the market. Adam Fleck tested a couple of strategies head to head and crunched the numbers to prove why. The director of research for ratings and ESG for Morningstar Research Services is here to explain what he found. Thanks for being here, Adam.

Adam Fleck: Thanks for having me.

Does Market-Timing Work?

Hampton: Let’s get this out of the way. What did your research say about market timing? Does it work?

Fleck: Well, generally, no. Despite having loads more information at a timely fashion over the past 20 years, nearly zero commissions and trading costs and of course a very volatile market, the mantra don’t try to time the market seems to hold up.

A Market Signal for Investors

Hampton: I mentioned earlier that you did the math. Thank you for that. You looked at the market going back to 2002 and examined it through the lens of Morningstar’s equity analysts’ market valuations. Can you talk about the signal that emerged?

Fleck: That’s right. So we looked at Morningstar equity analysts’ fair value estimates for the nearly 700 U.S. stocks that they covered. And we built a monthly aggregated ratio of the market price to those fair value estimates using a market-cap weighting. And the results are actually pretty encouraging. What we find over a three-year period after each monthly reading is that the market generally generates higher returns when it was deemed to be undervalued and saw lower returns or even negative returns when it was deemed to be overvalued. So, I think that’s a really encouraging signal that we found going back to your point over 20 years.

Market Timing vs. Buy and Hold

Hampton: What if an investor used that signal and shifted back and forth from stocks to cash depending on market valuations? How would have that portfolio performed against an all-stock, buy-and-hold portfolio?

Fleck: This is really where the rubber meets the road. Despite seeing that positive correlation between return and the market valuation, we found that a buy-and-hold, come-what-may, steady equity strategy still outperforms a portfolio that we built that tries to time the market.

So, just a little bit of background. To try to build this portfolio, what we did was build a hypothetical income stream for an investor that comes in monthly and put it in stocks if the market looked undervalued and put it in a cash account if the market looked expensive and overvalued, and then only reinvested back into stocks when the market looked attractive. But what we found was a buy-and-hold strategy that just puts all of that income into stocks no matter the valuation beat the market-timing portfolio by about 10% cumulatively over 21 years. So not a huge amount, less than 1% annually, but still something to pay attention to no doubt.

What was interesting was it didn’t seem to really matter when we started the study. The outperformance was a little narrower if we started the study when the market was overvalued. But nonetheless, there were very, very few periods and really only recently, again, within that three-year time frame of positive signaling of our price/fair value estimates that the market-timing portfolio even was able to beat the steady equity portfolio.

Of course, returns are only one aspect of this. We also have to think about risk. You might imagine a stock portfolio that’s always investing in the market is going to be riskier, more volatile than one that occasionally moves money in and out of cash, which of course is a lower-risk investment. But nonetheless, investors were more than compensated for this risk. The buy-and-hold, steady equity strategy had a higher Sharpe ratio than our market-timing portfolio. So all in, I think it’s safe to say that trying to time the market in this way is a very, very difficult strategy.

Why the Portfolio That Relies on Market-Timing Underperforms

Hampton: Why did the portfolio that relied on market-timing underperform?

Fleck: The main problem is cash drag. So while investors in a market-timing portfolio would enjoy, based on our backtesting, higher returns by putting money to work in the market when stocks were cheap, that’s more than offset by losing out on the returns by holding back on investing when the market screened is overvalued. So, even though those return streams were lower than a cheap market, stocks tend to go up over time and usually go up at a rate much higher than the interest you’d earn on your cash. And remember, too, over this 20-plus-year period, for a large portion of it, cash rates were essentially zero. So, holding back and trying to only buy when the market was cheap, loses out on a lot of that appreciation and a lot of that ability to compound your returns over time. The end result here is that staying fully invested tends to win out.

Hampton: All right. Well, Adam, our audience can check out your article to see the charts and tables, check out the show notes. Thanks for being here today.

Fleck: Of course. Thanks for having me.

Remembering Charlie Munger

Hampton: A note before we go. The investing world is remembering legendary investor Charlie Munger. He passed away this week at the age of 99. The longtime investing partner of Warren Buffett was known for sharing his thoughts on practical, fundamentals-based investing and his wry humor. Check out the show notes to read “12 Lessons on Money and More From Warren Buffett and Charlie Munger.”

Thanks for watching this week’s episode. Subscribe to Morningstar’s YouTube channel to see new videos from our team. You can hear market trends and analyst insights from Morningstar on your Alexa devices; say “Play Morningstar“ Thanks to senior video producer Jake Vankersen and lead technical producer Scott Halver. I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Take care.

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