Victory

SimilaritiesIn both 1999 and today, the stock market exhibits strong momentum and a herd mentality, particularly among the largest, most valuable companies. This is evidenced by the significant valuation differential between the market capitalization-weighted S&P 500 index and its equally-weighted counterpart. Currently, this differential is as pronounced as it was in 1999, just before a significant technology stock correction. As we delve deeper, it’s crucial to remember that while trees do not grow to the sky, the same holds true for stock valuations. Valuations Adjusted for CyclicalityValuing stocks using long-run averages of earnings, such as those used in the graph…

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From last October’s lows, the total value of stocks in the United States is up another $10 trillion. Sitting near $55 trillion, the U.S. stock market is now within a stone’s throw of record high valuations. At the same time, profits and profit margins for the largest public companies in the S&P 500 index are also at levels not seen before. There are few signs of stress in financial markets, despite much handwringing over the Federal Reserve’s (Fed) next move. If there were real concerns that high interest rates were about to sink the economy, it is highly unlikely that…

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Imagine this: The U.S. economy had a stellar year last year, outperforming Europe with a robust 2.5% growth rate. This is a far better performance than almost anyone imagined. It was better than most economists, pundits, and forecasters thought possible a year ago. Yet, not only did the economy grow far better than expected, but investors got hooked on risk again. Novel AI technologies captured investor imaginations, leading the tech-heavy Nasdaq Composite Index to trade at a near-record 60% premium to the S&P 500 based on enterprise-value to cash flow multiples (Nasdaq now trades at 24.3x versus S&P 500 at…

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Qualityland

At Washington Crossing Advisors (WCA), we go to great lengths describing the high quality businesses selected in our Rising Dividend and Victory equity portfolios. We believe in buying quality companies at reasonable prices that have low debt, predictable cash flows, and are highly profitable and reinvesting back into their business. This follows an intuitive, common sense approach to investing, particularly when considering risk-adjusted return in a strategy. That said, quality investing often becomes convoluted and misunderstood by investors – mainly due to antiquated frameworks put into practice decades ago that have unintentionally become foundational to investing and financial planning. In…

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Page through any investment brochure, factsheet, or presentation, and you’ll eventually get to the disclosure language claiming “All investing involves risk.” For fixed income investors, credit spreads over risk-free U.S. treasuries provide a sense of the interest rate, reinvestment, and credit risk they assume when buying corporate bonds. Along the same lines, stock investors must consider inherent risks in the equity markets when facing investing decisions. The Equity Risk Premium (ERP) indicates the price of risk in equities and is a key metric in determining the appeal of owning stocks versus bonds or other assets at any given time. What…

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Many managers use textbook financial ratios such as return on equity, debt to equity, and earnings per share variability to evaluate the quality and value of a company. However, these metrics can be easily manipulated by a company’s management and misused by index providers and rating agencies. For example, the return on equity ratio can be increased overnight by issuing debt and using it to buy back stock rather than investing in the business to promote growth. This can create an illusion of higher profitability without actually improving the company’s business operations. Distortions Caused by Share Buybacks To better understand…

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Consistency is a big part of quality. Our search for consistency leads us to companies that generate dependable growth. And the most consistent growth engine of the world’s economy — decade after decade — has been the consumer. Household consumption sits at the center of our economy, accounting for over 70% of all activity in the United States. When threatened, government intervention has been there to help shore up consumption, come what may, and from administration to administration. The reason for such policies are simple: employers all across the economy ultimately hire, invest, and produce to serve consumers. If consumption…

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Quality and Certainty

The only sure thing in investing is the uncertain. When we began the year, bearishness was rampant. Most Wall Street forecasters were expecting a recession, and the International Monetary Fund (IMF) warned the “worst is yet to come.” Thus far, the dismal outlook of these forecasters has yet to materialize. The lesson is that accurate and precise forecasts are rare. So how do we deal with uncertainty? We plan for the unexpected by continually focusing on quality. Fixing the roof when the sun is shining is far easier than when it rains! The S&P 500 is up 18% year-to-date, with…

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What comes around goes around. What has been going on for the past few years may now be coming to an end. From the pandemic lows of March 2020, low-quality stocks rode a wave of liquidity that is now receding. The roughly $5 trillion of new money creation, and the transfer payments that followed, encouraged risk-taking. After taking a beating at the onset of the pandemic, low-quality stocks suddenly became en vogue after March 2020. From that bottom, low-quality stocks rose 170%, as high-quality stocks rose 104%. But this situation now is going the other way. The Situation Now The…

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This morning’s lead story in the Wall Street Journal is about the resilient U.S. economy. According to the report, strong hiring, consumer spending, stock market, and housing trends are all helping. Yet, a closer look shows some peculiar disconnects. Productivity fell again last quarter, manufacturing is rolling over, and the money supply is falling. Moreover, higher interest rates pose a challenge as the S&P 500 moves toward bull market territory. Case for Growth Last week, a scorching hot May jobs report showed the U.S. economy adding 339,000 jobs, far above expectations. Private payrolls grew 283,000, up 2.7% from a year…

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A New Bull Market?

The S&P 500 is up 8.8% for the year through May 25. So, we should start celebrating a bull market, right? But look deeper, and a different picture emerges. Take away the top ten, mostly technology, names, and the market return falls to zero. Moreover, those ten stocks performed horribly last year, with an average decline of 43%. The average stock in the broader market, defined as the largest 3,000 stocks in the United States, is also flat for the year. Such narrow leadership is not what we expect in a full-bore bull market. Stumbling Block The market hit a…

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Like it or not, debt negotiations and shutdowns are integral to the political process, recurring over the past 50 years. The fear of a budget impasse, shutdown, default, and debt downgrade has again gripped the markets. However, it is unlikely that lawmakers will allow a debt default, following instead a familiar pattern of bipartisan argument, brinksmanship, and, finally, compromise. While an outright U.S. government debt default is improbable, we should emphasize quality due to its numerous benefits. Durable, flexible, and predictable firms tend to fare better in uncertain times. In contrast, financially weak firms are more susceptible to government default…

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