Earnings sustainability and equity returns

Nothing lasts forever. Many believe that trends are sustainable over the long term, but that is not the case, so today’s trend or growth rate may not tell us what will happen tomorrow. Too often, analysis compares two variables with the same timeframe when it is important to look to the future. In the case of long-term earnings growth, strong earnings today are not linked with strong forward performance. The chart above shows long-term earnings growth and compares it with forward earnings. There is a strong negative relationship. We should see forward earnings versus forward returns, and current earnings growth versus current returns, to close the loop on different combinations.

The end result is the same. Stock returns are tied to forward expectations, not what has happened currently or in the past.

Kahneman's solution to system1 thinking

 

Daniel Kahnemena came up with the idea that people either use system 1 or system 2 decision-making. In system 1, the brain makes impulsive decisions with little analytical thought, leading to behavioral mistakes. In the case of system 2 thinking, the brain slows down and uses analytics and logic to mkae decisions. There is nothing wrong with system 1 thinking when appropriate, and using system 2 for all thinking may be exhausting. Nevertheless, to combat the problems of system 1 thinking, Kahmean uses the SODAS problem-solving framework.

The SODAS acronym stands for situation, options, disadvantages, advantages, and solution. To bypass the automatic System 1 mind, the decision-maker should first define the exact problem faced, then review or brainstorm possible options to handle the situation. Third, the decision-maker should list the disadvantages and then the advantages for each available option. Finally, the decision-maker should select the best solution after the review. The SODAS method. It’s not the first, nor the last, method for making better decisions. It is simple and direct, and anyone can try it. 

Follow those small cap stocks; not the overvalued mega-caps

 

With all of the talk about the AI revolution and the Mag 7 over the last year, many investors have missed a really strong investment story - the rise of small-cap stocks. 

There has been a strong move in 2026, but more importantly, there is strong outperformance versus the megacaps. The market is signaling it wants to rotate out overvalued large caps and start putting money to work in smaller caps. Whether the story is about extreme overvaluation or opportunities in smaller, riskier names, the result is an opportunity that we have not seen for some time. There has been the view that the small-cap premium is dead, but there seems to be new life in these names that requires a second look.

Gun violence - the solution is following the research

Finished reading Unforgiving Places: The Unexpected Origins of America's Gun Violence by Jes Ludwig of the University of Chicago and I am once again awed by the power of good economic research. I may have had some biases before starting the book, but I had an open mind to learn about one of the worst problems in America. 

Ludwig also presents his case and evidence without any political bias. He wants to get to the heart of the issue, and, as with many economic problems, the obvious is not always right. Most of our views on many topics are, at best, only partially correct and do not serve as the only answer. Ludwig presents all sides of the argument about why there is gun violence and what possible solutions there are, but the main driver is behavioral economics. Gun violence is not about rationality but often irrational or, as Kahneman says, system 1 reactionary thinking. You put guns in the hands of people that have different reactions to situations not based on rational but on react, fight or flight thinking, and there will be a problem with tragic results. He makes a strong argument that many current models cannot explain why two neighborhoods that are adjacent and have similar demographics can have very different gun violence statistics. The only explanation is behavioral and social interaction between individuals. The poverty argument cannot explain gun violence - there are too many contradictory facts, and the idea of "bad people" does not explain the majority of violence, nor can using jails be the solution. 

For something inherently political, this book is well-written, thoughtful, and shows the power of good research that is able to separate common opinions from real facts.