April 19, 2022

COACH K AND THE HEELS:
THE RIVALRY THAT MOVES MARKETS

by Adam J. Morgan, CFA, CMT

As I was preparing to watch the Final Four, a setting befitting   the best rivalry in all of college basketball and the 100th game between Coach K and UNC, suddenly, out of nowhere it hit me like an Oscars slap! What if the Tobacco Road rivalry is even bigger than we all realize? Walk with me here… 

Mike Krzyzewski became the head coach at Duke in 1980, during a recession. The yield on the US 10 Yr. Treasury was 12.85% when the Tar Heels handed him his first loss later that year on December 5th. Interest rates have been coming down ever since, until recently of course, when Coach K announced his retirement. A couple of years later Michael Jordan’s Tar Heels would sweep Duke and go on to win the National Championship, also during a recession. The country wouldn’t endure another recession until the one that ended in March of ’91, the same month Coach K won his first National Championship. Everyone knows that the stock market went gangbusters throughout the 90’s, except for 1994 when the S&P 500 and Coach K took a year off. The next US recession occurred in 2001. The National Champion that year? Yup, Duke.  The recession of ’01 kicked off a painful bear market that lasted until early March 2003, reversing almost on the very day that Carolina broke a three-year slump against Duke with a win at the Dean Dome. That year the Tar Heels were coming off their worst season ever where they went 8-20 and lost to Duke by 29 points at home. Most UNC faithful blame Coach Matt Doherty for those years, but maybe they should’ve blamed the bear market.

A few years later during the financial crisis, President Obama was credited with famously calling the market bottom when in a press conference on March 3, 2009, he said, “What you’re now seeing is profit and earnings ratios are starting to get to the point where buying stocks is a potentially good deal.” The market turned around six days later on March 9, 2009. But what all of America completely overlooked is that Tyler Hansbrough scored 17 points in his last home game and beat Duke to win the ACC the day prior, on March 8th. The worst recession since the Great Depression was finally over and wouldn’t you know it, Carolina would win the National Championship a month later. Coincidence? Well actually… Yes. Unfortunately, sports fans, any correlation between economic or market outcomes and the UNC/Duke rivalry are spurious. But you already knew that. 

So, what really makes the market do what it does? In the near term, uncertainty, or a lack thereof, is a driver of markets. Fear about inflation or resulting Federal Reserve policy can create uncertainty. So, too, can a maniac overseas who starts a war for no good reason. But in the intermediate to longer-term, markets are more correlated to the growth of corporate earnings. When you own a share of a stock you own a share of that company’s earnings. The value of that share can be volatile when there is reason to be uncertain about the eventual realization of the future earnings already baked into the current share price. The recent pivot in Fed policy has investors worried about whether or not the future economic environment will allow for companies to realize the same earnings growth that was priced into stock values in the last rally that ended in late 2021.

After all, investors know that it wasn’t actually Coach K that caused the dramatic turn in interest rates in the early 80’s, but rather the aggressive monetary policy spearheaded by then Fed Chair, Paul Volcker. And we did experience two recessions in the three years following Volcker’s shift in policy. (By the way, Volcker was 6’7 and played basketball at Princeton.) So, should we be worried now? Let’s look to corporate earnings for some guidance. 

Below is a chart of the S&P 500 dating back to 2007, and the growth of the underlying corporate earnings of those same 500 companies. The blue line represents the S&P 500, and the red line represents the consensus forward-looking next-twelve-months estimate of corporate earnings. The shaded areas are recessions. The first thing to note is the long upward trend of both. My eye is then drawn to the steep drops during recessions and the strong recovery coming out of them. Most people agree that it felt odd to see the market recover the way that it did in 2020, in the midst of a global pandemic. But even more aggressive was the recovery in corporate earnings. Companies did a phenomenal job adjusting business models and popularizing concepts like “work from home,” “curbside pick-up” and “contactless delivery” in order to continue to do business under extreme conditions. Capitalism prevailed once again. 

Now it’s true that those forecasted estimates of corporate earnings could prove to be too optimistic. But with a labor market hiring at a rapid pace and a population itching to get back outside to enjoy life, it doesn’t appear to be the environment where corporate earnings contract, at least not yet. There are challenges facing our economy that we’re monitoring closely and there are always reasons to worry but don’t let the recent drop in the stock market convince you to change your long-term investment plan. In fact, dating back to the first time Carolina and Coach K faced off in 1980, the average intra-year decline in the S&P 500 is 14%, and yet the annual returns have been positive in 32 of those 42 years. Furthermore, in almost all of the ten years where the market didn’t yield a positive result by year-end, corporate earnings were actually down instead of being up less than analysts had forecasted. I know of no one currently forecasting negative S&P 500 earnings growth for 2022. Then again, anything is possible now that Coach K just ended his career with a loss to the Tar Heels.—A. Morgan

Nothing contained in this post is intended to constitute legal, tax, securities or investment advice, nor an opinion concerning the appropriateness of any investment, nor a solicitation of any type and does not guarantee future results. The information contained in this post should not be acted upon without specific legal, tax and investment advice from a licensed professional. Past results are not indicative of future performance.