Weekly (distribution list)
As 2023 comes to a close and investors look back over the past two years, one can’t ignore the paradigm shift in rising interest rates and its far-reaching effects on markets and the economy. After all, investment portfolios, mortgages, savings accounts, and auto loans, to name a few, have been drastically impacted by rising interest rates, which stand at 5.25% today. To put it into perspective, we have not seen a Fed Funds Rate this high, achieved in such a short period, in over 35 years (see Chart A). Against a backdrop of high rates, risk, and recession uncertainty, it…
Steady dividend growth often follows consistent profitability and shareholder-focused management. A dividend growth perspective looks beyond today’s yield and considers other factors, such as durability, flexibility, and consistency. A track record of dividend increases can be viewed as a tangible signal by a company’s management that they are both willing and able to boost a payment to shareholders. This commitment suggests quality fundamentals today and an expectation of continued improvement.
Although the economy is faring better than expected this year, we see a mixed bag of signals. Forexample, while popular market-capitalization weighted stock indices are up for the year, the average stock is essentially flat. Moreover, the outlook for corporate profits and capital spending are flattening out, suggesting muted growth in the private sector ahead. Similarly, monetary and fiscal policies have diverged. Monetary policy is restrictive (higher interest rates), while fiscal policy is expansive (rising deficits). Cross currents such as these lead to a neutral read of incoming data, suggesting we keep portfolio risk exposure very close to benchmarks.
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…
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…
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…
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…
As we pointed out in our Viewpoint 2023, the air of gloom that hung over markets at the start of the year was extreme. Instead, we saw improving fundamentals and opportunity for the situation to play out better than expected. So far, the economy and markets have proven resilient in 2023 with equity markets and the economy turning in better-than-expected performance. While the economy rolls along, however, there are some crosscurrents in the data leading us to avoid large tactical bets at the moment. Conquest Portfolios
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…
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…
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…
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…
Consistency is not flashy. Consistency does not take center stage. Consistency does not make headlines. Yet, consistency wins the day when predictability is in short supply, as it is now. With many observing that the recession risk is high, earnings could be at risk. Sales and profit margins for the S&P 500 companies are rolling over. Forecasted earnings trends are also headed down. Several high-profile companies that boasted stellar growth in 2020-2021 are falling flat. For this reason, we thought we should focus on consistency — one of the three pillars of our definition of “quality.” Consistency Defined When evaluating…
Surging inflation and interest rate expectations undermined stock and bond markets last year. There are nascent signs these trends may be reversing. Accordingly, stocks and bonds have rallied so far in 2023, despite the emergence of concerns in the banking sector. After a period of being slightly underweight equities, we have aligned tactical portfolio risk exposure close to benchmarks to reflect improvement in our WCA Barometer, coupled with a wide band of uncertainty around the forecast. Conquest portfolios
Index funds have gathered a devoted following since their debut in the 1970s. According to the Investment Company Institute, passive indexes and exchange-traded funds (ETFs) were 43% of the $29 trillion mutual fund industry. A main selling point of the funds is their “hands-off” nature, requiring little ongoing research or knowledge. But these funds are more active than you might think. While the funds do mirror an index’s composition, the index itself can change a lot. Those changes can be more significant than you think and introduce unwanted risks. Set and Forget Strategy An appeal of passive funds is their…
We believe a link exists between a business and its stock price. This is why we spend time thinking about businesses when building portfolios. If there was not a link it would be useless to spend time doing fundamental research. Considering the past five years’ volatile market environment, we thought now would be a good time to see if fundamentals, especially relating to quality, translated into differences in stock price performance. The Test (2018-2022) We set the stage by studying businesses and price performance from 2018-2022. From the onset, we gathered fundamental data on large U.S. companies by market value….
Quality companies grow when they make investments and expand profits. Other companies get in trouble when they make unprofitable investments. The whole idea behind investing in stocks (equity) is to grow. Fixed income is generally considered suitable for stable income; hence the name “fixed.” Long-run stock investing, by contrast, requires survival and profitable growth. Even though profitability alone does not guarantee the “best” investment in each year, focusing on high profitability is a good start because such companies are more likely to grow and create value, especially as funding costs rise. The Profitability-Value Nexus We are not saying that all…
We are starting to see some light at the end of the tunnel. The stock market is up for the year, inflation has begun to decelerate, and the labor market shows continued strength. These positive signals push back against the recession and inflation story that hung over markets for most of the past year. The improved backdrop is also reflected in our WCA Barometer (chart A, below). While the current forecast reading of 48 (the blue dotted line) is not robust, it is anticipating some stability and lift after a long downward slide. While the lift could prove fleeting, it…
With 2022 in the rearview mirror, we have hit the ground running, eager to shake off the previous year’s dour market mood. Despite the prospects of recession, persistent (albeit declining) inflation, and restrictive central bank policies, we see pockets of momentum and optimism in 2023, particularly in foreign developed markets. For the past decade, U.S. equities dominated and were the most sought after markets for risk assets. However, this situation is changing. Rising Returns One month into the New Year, we are seeing strong gains across the board in foreign markets. The following table provides local currency and USD returns…
High-quality stocks beat low-quality stocks in every problematic market for the past twenty years, but not in 2022 (table below). In each bearish phase, high quality held up better than low. However, this was not the case this year. Year-to-date, the WCA High-Quality index is down 15%, while the WCA Low-Quality index is down just 5%. While this trend is changing with recent performance once again favoring high quality (more on this below), this year’s performance of high-and-low quality needs some examination. High vs. Low-Quality Performance in Bad Markets Before doing so, we remind readers that quality is important but…
The International Monetary Fund delivered a sobering assessment of growth in their latest outlook. High inflation, war in Ukraine, and lingering supply issues are culprits. While credit spreads and earnings forecasts appear reasonably steady, our own assessment of data points to slowdown. As we look for signs of a turn, the weight of evidence points to some continued caution for now.
Last week, the European Central Bank (ECB) raised a red flag, saying some member banks have ignored warnings of risks associated with leveraged finance, according to Bloomberg News. The ECB hit a handful of European banks with capital charges in an attempt to encourage the banks to exercise greater caution. These actions come amid growing concern in Europe over a looming energy crisis, ongoing war in Ukraine, and struggles at some financial institutions. These pressures are evident in both confidence indicators like business confidence (graph A, below) and measures of financial stress (graph B, below). Graph A Graph B Rise…
Earnings drive stock prices over time. This simple truth is evident in the past century’s market performance. Over the past 100 years, both the S&P Composite index and S&P Composite index earnings gained about 6-7% per year. The profits, along with the market’s appraisal of the value of those earnings, rose and fell year-to-year. Sometimes, those swings in earnings and valuations were large, creating excitement and anxiety. What drove the earnings growth? Fortunately, we see an excellent and rational cause for the growth in earnings. As the chart below shows, we can trace growth in stock prices to economic growth…
Central Bank all in to fight inflation Markets signal inflation to fade Rates to push higher still Policymaker credibility key to fight Valuations more attractive. We remain cautious based on incoming data and enter the final quarter underweight risk assets.However, policy priorities seem to be having some positive effect on expected inflation, despiteupsetting financial markets. This is a difficult and complex environment, and we continue to followour tactical discipline in navigating a very unusual year. While we are not out of the woods yet,valuations are becoming better as are longer-run expectations for returns.
Investors have done well to heed Marty Zweig’s advice “Don’t fight the Fed” since he published his 1970 book, Winning on Wall Street. The idea has generally stood the test of time. The most recent two major recessions and market declines, those in 2000-2002 and again in 2007-2008, were preceded by Federal Reserve (Fed) policy tightening. So too were the recessions and bear markets of 1973-1974, 1980-1982, and 1991-1992. The 1987 market crash was, likewise, preceded by rising rates. In each case, efforts by the Fed to rein in inflation via tighter monetary policy proved effective in fighting inflation, but…
We critique existing “style” investing frameworks as popularized in various “value” and “growth” indices. We cite three critical problems with how the indices are constructed, and discuss risks that come with overly strict adherence thereupon. Lastly, we offer an alternative framework as a potentially better way to think about investments.
The economy is either in recession or booming. This is what the headlines are telling us each week. So, against this muddled stream of seemingly conflicting and contradictory information, we look for signs regarding which way we are headed. Consider the following evidence for the “recession” case and the “boom” case.
While we usually comment on financial assets like stocks and bonds, real estate also plays an important role in the broader economy and financial markets. With signs of possible cooling now emerging in property markets, we consider what a slowdown in real estate could mean for the U.S. economy and financial markets at large.
Set against a backdrop of rising inflation and interest rates, calls for a “technical recession” are growing. Our check of the data leads us to maintain our near-term, tactical “underweight” to stocks. However, the correction in stock prices contains a silver lining as valuations have become better, boosting long-run return expectations.
As inflation surprises markets, we consider what this means to investors and what policymakers are likely to do.
Apart from a short downturn early in the pandemic, the stock market has enjoyed a great bull run since 2010. Yet, from January 3 through May 20, the stock market fell about 18.5% before rallying 5% off the recent bottom. Despite the recent rally keeping the market out of “bear market” territory, we should not let down our guard because growth is still slowing. A lapse into outright recession would complicate the bull case for stocks through year-end.
On the surface, valuations appear to be coming back down to earth. The Standard & Poor’s 500 stock index has declined to nearly 4,000 from almost 4,800 in January. Back at the January peak, forecast year-ahead earnings for the index stood at $223, and now those forecasts are at $237. Today’s price-earnings ratio is 17x compared with 21x in January and in line with the 10-year average. So, stocks are moving down despite rising profit forecasts, resulting in better value.
The first quarter brought a surge in inflation and war in Eastern Europe. This environment imposes a new reality on investors and policymakers. In this report, we discuss what is happening and how our top-down portfolios are positioned now.
Against a backdrop of falling consumer expectations, we consider what a “typical” cycle tends to look like. As an old aphorism states: “History doesn’t repeat itself but it often rhymes.” We offer a highly “stylized” interpretation of market cycles to consider the current situation.
Our process for tactical asset allocation involves assessing data. Specifically, we assess month-to-month trends in data. When Russia began a full-scale invasion of Ukraine in late February, most of the trends we follow seemed poised to bounce. Obviously, this is no longer the case. This week we assess how recent data is influencing our outlook.
Russia’s invasion of Ukraine, and the West’s initial response, casts a veil over Eastern Europe. This veil of uncertainty can be unsettling as we confront many unknowns. This week we look at what actions are being taken and how these actions may influence the investing landscape.
The stock market is near $50 trillion in value, about $15 trillion greater than before COVID-19. Stock values rose far faster than bonds, market earnings forecasts are hitting new highs, and companies are finding it easy to borrow. Yet there are signs that this happy situation could be poised to change. This week, we look at some recent evidence to support this claim.
Where do you want to be invested when faced with the prospect of a bear market? Some say that high dividend yields provide protection when stocks fall. This implies that since the yield rises as the stock price declines, new buyers will be attracted as the price drops. Such buyers could help establish a “floor” below the stock. While this sounds good in theory, we find scant evidence that it actually works in practice. This strategy fails when needed most because “high yielders” tend to be fundamentally weak. While some high-yielding stocks may be good bargains, most high yields reflect…
We publish this year’s Viewpoint 2022 amid ongoing recovery from an unprecedented pandemic. Signs of continued growth are apparent despite new COVID-19 variants and anticipated policy shifts. Long-run return expectations fall this year in as valuations and profit margins are elevated for stocks. For fixed income investors, surging inflation and expectations for rising rates are of primary focus.
Despite an ongoing economic recovery and bull market in stocks, we see a growing set of reasons suggesting some caution may now be warranted. In this week’s commentary, we will lay out these reasons and offer some ideas for navigating more challenging market environments.
With the U.S. stock market near highs, we look at the role “beta” plays in portfolios and why we favor combining “beta” with fundamentals. We find that 1) the pandemic era brought a rise in average “betas”, and 2) that “betas” behave differently based on fundamental quality.
In the very long run, it is growth that dominates other drivers of return. In this commentary, we look at why valuations and profit margins matter less than growth over time. With profit margins and valuations at or near highs, we conclude that we should not depend on further increases in margins or multiples for return. Instead, growth and dividends will become more important for us as long-term investors.
As the consumer price index rises faster than any time in 40 years, we look back at how American economist Milton Friedman and statistician Janet L. Norwood helped shaped today’s understanding of “inflation.”
After an initial strong run, signs of stress may now be emerging in the global recovery. Moreover, we note that financial markets appear priced for strong growth, record profits, and limited financial stress among corporate issuers. Given this backdrop, we now tactically reduce equity exposure to neutral following fourteen months of significantly overweight equity exposure.
The pandemic provides a test for our crucial proposition that dividend growth points to quality. We look at recent evidence since the pandemic’s beginning to test this proposition. We find great similarity in performance of dividend growers and high quality on the one hand, and dividend cutters and low quality on the other. We also question whether the risk of owning this year’s outperforming low-quality, dividend cutters is really worth the much higher volatility of such stocks.
We discuss the recent record-breaking rally, what is driving it, and the potential impact of higher prices on future returns. Also considered is the impact on wealth and appropriate portfolio strategies are suggested.
There is more risk in the world than most people realize, and it is often inadequately measured. Here we look at how we measure risk and how quality can help address both volatility and unwanted surprises.
Investing is not just about creating high returns but consistent returns. Therefore, we must contemplate how to address risk well in advance of demanding markets. This commentary addresses how some basic math can help explain the value of investing in high quality.
Easy money policies and rising debt lead us to focus on quality first. In past commentaries, we made a case for owning high-quality firms over low and offer an alternative to “growth and value.” This week, we want to explore how we think about what we pay to own high quality. How We Asses Quality When we say “quality,” we really mean flexibility, resilience, and consistency. To find these characteristics, we test firms for low debt, productive assets, and operating consistency. Each quarter we examine the largest 1,000 U.S. companies along these lines, rank the results, and assign quality grades…
The gardener must sow seed in fertile ground for a garden to grow. Once planted, young seedlings must be cared for and cultivated. If all goes well, the seed grows into an abundant garden, while also producing the seed and nutrients for next year’s plantings. In this way, the gardener achieves a sustained cycle of growth, and everyone benefits. The same is true for a business. Like a seed, a firm must sow investments in assets that yield a profit if it hopes to grow. Additionally, investments will be subject to risk and unknowns, some will produce profit, and some…
As the economy reopens, we believe growth is set to surge. The United States is well along the path on vaccination, which is unleashing months of pent-up demand. Meanwhile, other parts of the world are lagging in vaccinations and confronted with potential challenges, including a stronger dollar. Given continued signs of progress and growth in the United States, we refocus tactically around domestic and high-quality assets. We also maintain a tactical overweight to equity over bonds, given incoming data as we enter the third quarter.
Our economy grows decade to decade, with corporations capturing an increasing share of global income in the form of profits in recent years. Along the way, low interest rates prompted growth, encouraged risk-taking, and pumped up the value of future profits. It is not surprising, then, that stocks have enjoyed a historic rise, achieving great returns far above other asset classes. Not even a global pandemic was able to short-circuit this wealth creation process. In this week’s commentary, we revisit an old idea — namely that real factors dominate growth and stock returns in the long-run, while illusory factors can…
Dividend growers outperformed all dividend categories for the past 48 1/4 years with less risk. This is our conclusion based on data provided by Ned Davis Research. The research focuses on dividend payers, non-dividend payers, and dividend cutters. Note that the pattern of dividend growers outperformance holds for both the entire period of analysis and each sub-period (First Table). It also holds that growers experienced lower volatility for both the entire period and each sub-period (Second Table). In this note, we address why we think this phenomenon exists and what it could mean to investors. Return By Dividend Category (Annual)…
Is there a way for bond investors to win if interest rates rise? We think laddering bonds is one way to navigate an uncertain and changing environment. First, we must start with a simple fact. Nobody knows for sure what will happen to interest rates in the future. There are potential ranges of plausible outcomes, but in reality, the future direction of interest rates is unknowable. What is knowable is today’s level of interest rates. So, an investor interested in knowing the nominal dollar return of a T-bill or zero-coupon U.S. Treasury can know that future return with certainty today….
To buy quality stocks that increase dividends regularly is a time-honored investing practice, and for good reason. This simple strategy takes a long-term view of investing and focuses on the dividend, not the stock price, which can help some investors maintain perspective. The passive income generated from dividend growth also has two side benefits. First, it focuses your investment strategy on cash-generating, growing companies. Second, it tends to lead to quality businesses that are neither too young nor too old. Why is this so? Almost by definition, a dividend-growing company tends to cover expenses with rising cash flow. And which…
The U.S. stock market has been on a tear of late, rising 56% in value, or $18 trillion, in the last year. Two-thirds of the gain came in the six months since October. Surging stock values mirror last spring’s rapid plunge, leaving many feeling elated, unnerved, and anxious. Are expectations for the world ahead justified and fairly factored into stock prices? Or is the bull run reflecting unrealistically high hopes? A Pretty Penny In our view, valuations are full. By most metrics, we see stock values at high levels. Just look at the value of U.S. stocks at $48 trillion…
It is essential not to overlook critical assumptions. One of the most basic stock investing beliefs is that firms will continue to exist — firms do not live forever. Beginning as a start-up and ending in decline, firms undergo many changes over their lives. An idea becomes a business that generates growing profits and revenue. As a result of sound investing, the company continues to grow, finds new markets, and fends off competitors. At some point, the demand for the firm’s product or service slows, competition erodes advantages, and the business shrinks. In an age of rapid technological change and…
President Biden signed into law a $1.9 trillion Coronavirus aid package last week. New spending of $1.1 trillion is expected this year, with the remaining $0.8 trillion spread out over the coming years. The spending is on top of last year’s $3 trillion fiscal support program, sets up 15% annual deficits for 2020 and 2021, and increases debt to 110% of GDP. Why should we care about such spending, especially when the economy is hobbled by COVID-19? Indeed, the package will indeed help many. There are $670 billion in checks and enhanced unemployment benefit checks on the way to…
Since the Georgia Senate races went to Democrats on January 5, forward expectations of short-term rates have moved up sharply (Chart A, below). With nearly $2 trillion of anticipated deficit-financed spending now in the pipeline, long-term U.S. Treasury bonds are also selling off, causing long-term yields to rise too. Investors worry that massive new COVID-19 spending, happening when financial markets are already flashing “risk-on” signals, may be problematic. Typically, such large stimulus occurs only when an uncertain economic outlook is rattling markets. Chart AForwards Markets Start to Envision Higher Rates A High Bar But fear is not really the prevailing…
Key Points: Vaccines Spur Growth Rebound U.S. Profits Recover to Pre-Pandemic Levels High U.S. Savings to Fuel Growth Stronger Dollar Favors Domestic Tilt Valuations, Rates, and Taxes are Risks Much has changed in the past quarter. A new administration and new congressional leadership has emerged in Washington. Meanwhile, a COVID-19 vaccination rollout is accelerating throughout the United States and some other parts of the world. Speculative fervor has rippled through some parts of equity markets while bond investors fret about rising interest rates. This quarter we address how these changes are shaping the environment, creating challenges and opportunities for tactical…
There is lots of discussion about the return of speculation. Cryptocurrencies, message board short-squeezes, soaring penny stocks, “blank check” companies, and record issuance of risky debt dominate today’s headlines. It is hard to imagine that, just under a year ago, financial markets were in freefall. Greed replaced fear in the span of a few short months, despite an ongoing pandemic. This week we return our focus to “quality” as a key factor in portfolio construction. Risk-On! Notice the chart below. It is a ratio of the most volatile stocks in the S&P 500 divided by the least volatile. When investors…
While risk-taking remains in fashion and more stimulus is on the way, we are trimming back some equity exposure. We now forecast some tempering in the outlook ahead (Chart A, below) after a long stretch of improving conditions. As a result, we reduced stock exposure to 67% from 80% and increased bond exposure to 33% from 20%. CONQUEST tactical asset portfolios remain overweight stocks versus bonds, only less so. Chart A WCA Fundamental Conditions Barometer High Hopes Since the governments and central banks around the world went “all-in” to save the economy from the pandemic last spring, wealth has exploded….
Many are expecting vaccinations to lead to a robust recovery this year. Return to normal and restart of the in-person economy should encourage growth and be celebrated. At the same time, the return to growth could also weaken the case for continued fiscal and monetary ease. And once restarted, the globe faces challenges. The tensions and ailments that existed before the pandemic are still with us. The path appears to be forward but it will not likely be a straight line. Last year’s pandemic-induced downturn was out-and-out different from recessions past. For this reason, we should see recovery as a…
The stock market is on a historic run, with U.S. stocks eclipsing $42 trillion in value for the first time ever last week. The broad market, measured by the S&P 500, continues a decade of strong returns with the rolling 10-year real return for the market above 10% (Chart A, below). Chart AS&P 500 Trailing 10yr Real Annualized Return Market of Stocks Many of this year’s “stay at home” themes are playing out and the technology sector is on a tear. Yet, this year reminds us it is not so much a “stock market” as a “market of stocks.” Even…
A month after the announcement of the first highly effective COVID-19 vaccine, positive momentum is building. Potentially game-changing vaccines, a new round of government spending, and continued, pedal-to-the-metal monetary policy are nurturing a boom environment as we end a most challenging year. While COVID-19 cases grow globally, and in the wake of the election, it is easy to lose track of market trends. In no particular order, here are a set of observations about recent trends worth noting. Observations: The value of all U.S. stocks is nearing $42 trillion, or 2 times the whole economy’s size ($21 trillion GDP). High…
Interest rates on bonds are at very low levels. The decline in the United States rates follows those of other sovereigns like Germany, the United Kingdom, and Japan (Chart A, below). In turn, global rates are following a long-established, declining secular trend. That trend leads to “negative” rates with more than $17 trillion in such debt circulating globally (Chart B, below). The defeating of inflation and worries of deflation may be behind this trend. Still, other factors may also be at work. Chart A U.S. Long-Term Treasury Yields vs. Average Foreign Yield (Germany, United Kingdom, Japan) Chart B Aggregate Global…
For years, stock investors have fixated on “style,” which means investing in “growth” or “value.” “Value” in this context is usually defined as buying stocks with low price-to-book or low price-to-earnings ratios. Some are now rethinking the very foundations of this framework as the return to value indexes continues to shrink (Chart A, below). Others are leaving behind simplistic notions of “style” investing and looking for all sorts of new factors to find performance. In our view, adding a multitude of new factors to the mix is also the wrong approach. The right perspective simply relates price to a few…
Investment returns are the reward sought by all investors, not small returns or unpredictable returns, but large and guaranteed ones. Unfortunately, those sorts of returns are imaginary. This is not to say that estimation, a more respectable form of imagination, is not in widespread practice. All investors imagine some sort of plausible future of some kind, with some sort of expected reward. These imaginings are behind every dollar invested in the world today. “By the end of the next decade, quite a way off, there will be a pandemic, and stock investors will achieve record wealth.” These words, if uttered…
The news of a Biden/Harris election win and heightened prospects for a COVID-19 vaccine are being digested by markets today. As for the former, news agencies declared Democrat Joe Biden president-elect and control of the Senate is to come down to two run-off races in Georgia. For the latter, hopes of a COVID-19 vaccine linked to an announcement of progress toward a vaccine sent global stock indices soaring this morning. The ground beneath this year’s two most dominant themes — politics and pandemic — is moving. The political shift is assumed to be toward the “middle” with an expectation of…
Today, The Wall Street Journal ran a front-page, above-the-fold article titled “Dividend Darlings Trail Stock Market Despite Pumped-Up Yields.” The authors point to underperformance by dividend payers within the S&P 500 Dividend Aristocrats index, an equally weighted index consisting of all S&P 500 companies that have increased dividends every year for the past 25 consecutive years. The article highlights some iconic dividend payers with large yields suffering large share price drops this year. So says The Wall Street Journal: “Exxon Mobil Corp., whose dividend yield is sitting at a near-record of more than 10%, has declined 51% in 2020… AT&T…
Roughly 160 of the world’s nearly 200 countries are considered emerging markets (EM), and approximately 6 billion people, or 85% of the world’s population, live in emerging economies (map, below). Thus, there are plenty of reasons not to ignore emerging markets in a portfolio. But there are special considerations unique to emerging markets. These include currency movements, different political and legal systems, greater exposure to commodity prices in some cases, and periodic debt troubles. However, none of this is new, and many emerging markets are evolving from immature, rapid growth toward more mature, slower growth. Even though growth may be…
As we start the fourth quarter, the major U.S. stock market averages hover around a 0% return for the year. That unexciting performance masks extraordinary volatility — a 35% February-March decline and a 50% March-August bounce back. Other assets demonstrated similar volatility (graph, next page). Through September 30, Long-term U.S. Treasury bonds returned over 20%, and Bloomberg Barclays Aggregate U.S. Bond Index returned 6.5%. Short-term T-Bills returned about 0.7%, and gold is up 24%. Volatility again ruled the roost in 2020, and diversified portfolios generally did better than all stock portfolios. As we head into the final quarter of 2020,…
Imagine an investment strategy wherein you might seek out the most successful and valuable companies. We will refer to this as the “big five” portfolio. Further, imagine that this “big five” portfolio bought the five most valuable companies in the Standard & Poor’s 500 index at each year’s end starting in 2000. Imagine further that this process was repeated each year ever since. How might this strategy of buying big and valuable stocks have done? The strategy produced positive returns, but the journey would have been painful and frustrating (chart A, below). Investing in the “big five” at the start…
Even though stocks should rise over time, we think the pace of the market rally is set to slow because extraordinary government supports for the economy are set to fade, and valuations have run ahead of fundamentals. Changing Tack It is hard to bet against stocks for the long-term. Since the 1920s, stocks have produced a positive return every 20 years based on S&P 500 annual returns. Stocks tend to beat bonds and cash over time, supporting the idea that markets tend to reward risk. But this fact obscures the reality that stock investing also involves periodic drops. Not everyone…
Years ago, it was easy to make money. Those who were around during the 1970s may even remember earning near 20%. A three-month CD in December 1980 earned over 18%, according to data from the Federal Reserve. Such rates are near 0.18% today — far below the core inflation rate (+1.3% year-over-year). At that rate, a $100 investment would grow to only $101.80 over ten years. Evaporating Interest Rates And don’t think buying longer-term bonds is the answer, either. Ten-year U.S. Treasury bonds now yield 0.7% compared to over 3% just two years ago. A $100 investment in a zero-coupon…
We continue to see improvement in several indicators from a very weak second quarter. It is likely that, after a 30% annualized drop in GDP in Q2, Q3 could see a 25% annualized rebound. Progress is also seen in weekly data such as the Federal Reserve Bank of New York’s Weekly Economic Index (WEI). This index tracks ten daily and weekly indicators of real economic activity scaled to align with the four-quarter GDP growth rate (Chart A, below). The WEI spotlights consumer behavior, the labor market, and production weekly. As beauty is in the eye of the beholder, so too…
It is hard to conclude almost anything with certainty amid this pandemic. Are schools open? Or closed? Or half-open and half-closed? There seems to be less unanimity in Congress on policy issues. The size of continued supplemental unemployment benefits was at issue before this weekend’s executive order. Republicans favored a $200 additional benefit, and Democrats wanted $600. President Trump’s $400 figure falls neatly in the middle of the $200-$600 range, but questions over the order and funding for the order remain. The “muddled middle” will have to suffice for now, but, by comparison, today’s situation is far better than where…
The best-performing stocks since the beginning of the pandemic have had one thing in common — a high degree of financial flexibility. The worst-performing stocks were the least flexible. Before we start, it is important to define “flexibility.” For us, it has always meant low debt and high profitability. These characteristics tend to build buffers that help ensure survival during difficult times. Where to Find Flexibility Technology stocks, for example, have been a good place to find flexibility lately. The average technology company is very profitable, with very little debt. The sector’s return on assets (10.6%) is higher than any…
Negotiations over a second stimulus round are underway, ahead of Congress’ early-August recess. News reports suggest President Trump’s team may be looking for a $1 trillion package focused on payroll deductions and support for unemployed workers that does not create “disincentives” for returning to work. By contrast, the House of Representatives advanced the $3 trillion HEROES bill in May. That bill seeks more significant direct cash payments to individuals, aid for states, and other measures. The GOP is expected to release details of its plan over the next few days. Whatever the final number, this will likely be the last…
Executive Summary: The second quarter brought a surge in stock values predicated on three critical assumptions. First, fiscal and monetary measures would be sufficient to support an economy suffering a tremendous hit. Next, the economy could begin a process of “reopening” and avoid a second wave pandemic shutdown. Finally, progress will be forthcoming toward a treatment or vaccine for COVID-19. While the future could always play out differently than expectations, equity markets seemed willing to focus on positives, rather than lingering unknowns, throughout most of the second quarter.
The second quarter saw stocks roar back from March losses. Global shares rose 38%, and high yield corporate bonds rose 20%. Long-term Treasury bonds were flat, and gold was up 15% (chart, below). The rally began after global stocks fell by one third from February 19 through March 23 as COVID-19 spread outside China, and shutdowns began. Since March 23, markets focused on measures taken to deal with the pandemic and its effects on the economy. A $2.2 trillion stimulus package and extraordinary central bank actions triumphed over fear and uncertainty. Volatility reigned throughout the first half of this year….
This week closes out a most volatile quarter. Stocks are on track to rise by the most during the quarter (+19% as of this writing) since 2009 despite a sharp contraction in the economy. The powerful rally leaves many wondering about valuations amid a pandemic and recession. Even though price is important, we should avoid relying too heavily on standard valuation metrics such as price-to-earnings multiples because this economy is far too volatile to assess business prospects accurately and because stock values are determined mostly by long-run, rather than short-run, earnings power. Price is Important Overpaying for stocks can take…
A significant shift in financial markets occurred roughly twenty years ago. It was June 2000, and Federal Reserve Chairman Alan Greenspan had just raised the short-term interest rate to 6.5%. Within months, a falling stock market would lead the economy into a short and shallow recession. Unbeknownst to anyone at that time, the central bank would soon begin cutting rates further than they ever had before. In so doing, they would usher in a new era of easy credit. In this commentary, we make a case for investing in quality, especially during this ultra-easy credit era. Why do we call…
Last Monday, the National Bureau of Economic Research declared the longest economic expansion in U.S. history over. After beginning in June 2009, the expansion lasted for 128 months through February. Born in the depths of a severe financial crisis that started at home, many worried the U.S. would suffer a long decline. In the ten and one-half years that followed, the U.S. economy and markets outpaced most others, leaving domestic stocks with premium valuations. Even though U.S. stocks appear relatively expensive, we should remain tactically overweight domestic assets for now because dollar-denominated assets can convey significant benefits during times of…
Reopening the economy has stirred some optimism amid a wash of depressing forecasts. The Federal Reserve Banks of Atlanta and St. Louis have a model that estimates the U.S. economy may contract at a 42-48% annualized rate in Q2. For a more optimistic read, the Federal Reserve Bank of New York “Nowcast” estimates a 31% pace of decline in Q2. Thirty-six million lost jobs and record drops in both industrial output (-11% April) and retail sales (-16% April) are driving the slump. The second quarter is going to be a bad one, but recently markets seem to be looking beyond…
Some companies are cutting dividends as the economy weakens. A recent Barron’s article lists about sixty firms that eliminated, suspended, or cut dividends since February. We decided to look at the fundamental characteristics of the companies cutting dividends. To do this, we created an equally-weighted portfolio comprised of the stocks in the Barron’s article and asked several questions. What was the dividend yield at the end of last year, before coronavirus hit? What was the financial profile of the dividend cutting firms based on profitability, leverage, and dividend policy? Finally, what happened to the stock prices of those firms which…
Before we can hope to see a turn for the better, we must first see signs of stabilizing. For the most part, this is what we see in the most recent data. We try to discern the path to recovery in the week-to-week data: virus trends, by looking at cases and deaths across the United States; economic trends, by looking at mobility and reports of real economic activity; and market trends, by looking at the response of key financial indicators. This week’s analysis showed us that the economic hole is deep, but the rate of falloff is slowing. Slowing Spread…
Stocks rallied last week on talk of reopening the economy and the S&P 500 is about half way back to February highs. The lockdown is helping to slow cases of coronavirus, but the economy is taking a beating as a result. Judging by recent data, the U.S. economy is likely contracting at an annualized pace in the range of -15% to -22% (chart, below). Over 10 million Americans filed for unemployment insurance in the past month. Estimates of potential job losses range from 23 million (Goldman Sachs) to 47 million (St. Louis Federal Reserve). The speed of the present downturn…
An eruption of volatility hit markets last week as the World Health Organization declared Covid-19 a pandemic. This extraordinary outbreak will throw out of kilter many aspects of daily lives. Markets are rapidly reestimating risk and trying to predict the size and duration of the shock to the global economy. Central banks and governments are also stepping up response to unfolding conditions. Yesterday, the Federal Reserve cut their benchmark interest rate by 100 basis points (-1.0%) to a range of 0-0.25%, committed to buying $500 billion of U.S. Treasuries and $200 billion of mortgage-backed securities, and took other measures to…
Bond prices continue to surge, driven by coronavirus fears and a new oil price war. Prices of long-term U.S. Treasury bonds are rising rapidly, sending bond yields to record lows. Bonds at the longest end of the U.S. Treasury curve are approaching gains of 20-30% year-to-date. Similar bond price action occurred in the past, but never before have U.S. interest rates reached levels seen today. U.S. 20-year Treasury yields have now fallen through one percent, following the 10-year Treasury amid a broader global pattern of rapidly declining and ultra-low rates. The 30-year U.S. Treasury bond yield currently stands at a…
The spread of coronavirus outside China hit markets hard last week. Stocks fell on reports of new infections and deaths in Italy and elsewhere. The sharp drop in stock prices, coupled with a plunge in Treasury bond yields, leaves the S&P 500 dividend yield now higher than the 30 year U.S. Treasury yield (first chart, below). Domestic stocks suffered more significant declines than foreign due to concern the virus could spread in the United States (second chart, below). The chart shows pronounced weakness in the S&P 500 (a measure of domestic stock performance) versus the MSCI EAFE index (a measure…
Global business activity is taking an unexpected hit from worries over the coronavirus outbreak, according to recent data from IHS Markit. As the chart below shows, the IHS Markit purchasing managers’ index fell sharply through mid-February with U.S. Services Business Activity Index falling to 49.4 (53.4 in January), a 76-month low. The IHS Manufacturing Survey (below) also fell to 50.8 (51.9 in January), a 6-month low. New orders fell for the first time since data collection began in 2009. Hesitancy among firms due to coronavirus is causing a decline in business activity in the United States. This is the conclusion…
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The Case for Rising Dividends
A strong case can be made for dividend growth investing. The Case for Rising Dividends explores the rationale and evidence behind the dividend growth philosophy.
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