Thanks to everyone who turned out for our annual seminar on Tuesday, December 5. It was a festive atmosphere and there were a ton of great conversations between clients and Monarchians. The market’s great run in November surely aided and abetted the jovial mood.
Adam took us on a trip down memory lane, with a live-action chart video showing the 10 biggest companies (by market cap) every year since 1980. If you want to see the video, here is the link: https://www.youtube.com/watch?v=kfMFDcuDKYA. He then trained our attention on the top 10 at the beginning of each decade since; notable is that there are very few repeats of the names from one decade to the next.
Adam then shifted gears to Monarch’s core stocks, and showed how they have grown over the last 25 years. Americans are drinking less pop, so Coke’s volumes have inevitably dropped, right? Nope, they’ve doubled in that time. Then add on price increases and extensions into new business lines, and you’ve got good long-term sales growth.
John took the mic and honed in on one top 10 list: biggest companies at the end of 1999. Notably, only one company ever showed back up in the top 10. Can you name it? Perhaps it’ll help if we show you the list, and what the stocks have done since:
As the chart shows, the median stock underperformed the S&P 500 by 219% in the 23+ years since then. Will that be true of the current top 10 list? Will some or most of them fall off the list? History suggests the odds are good for both.
Tech looms large on this list, as it does on today’s list, and many of the justifications for why the “Magnificent 7” are so highly valued are the same as then. These were also dominant, in growing industries, cash-rich, and led by luminaries. Perhaps most instructive is Citigroup, the only financial that cracked the top 10 at the time. Why Citi? Citi had acquired Travelers in 1998, which brought Sandy Weill, a revered Wall Street veteran and dealmaker together with a revered (at the time) bank. I was actually working at Travelers at the time, which had just closed the deal to buy Salomon Brothers, where I was an analyst. Citi’s stock popped 25% on the day it was announced they were merging with Travelers. This set in motion a new era for corporate and investment banking, notably the creation of structured securities, which eventually opened the market for subprime mortgages, which helped create the Great Financial Crisis. Anyway, a long-winded answer as to why Citi made it to the top 10…and then crashed.
Fast-forward to today…the Magnificent 7 have dominated the market this year. The S&P 500 without them is basically flat. The DVY, an ETF that owns the highest-yielding stocks, is actually down 3% this year…including dividends. Some people have forgotten how miserably tech performed last year, as interest rates shot up and recession concerns quickly rose. If you count performance since the market peaked on 12/31/21, here are some salient market statistics:
Including dividends, the S&P 500 has crept back near the high of 12/31/21, only down 1%. The average stock in the S&P 500 is down 4%. Below the surface, small-caps are down 15%. Everything is down…even the Magnificent 7 and the Nasdaq!? Amazon is +72% this year, but including last year, it’s still down 13%. Monarch’s core stocks are down 2%, by comparison. Meanwhile their fundamentals keep moving in the right direction, with 7% earnings growth and 11% dividend growth.
We shifted gears to the macro. The pervasive narrative in the markets is that we have dodged a bullet, avoided recession, and thus it is soft landing all the way! We surveyed the crowd, first asking who thought we would have a recession. Only about 4 hands went up. Not to pick on the crowd, but they were chided for not noticing the open-ended nature of the question. We will for sure have a recession, someday. Asked whether we will have a recession by the end of 2024 or not, the crowd was split roughly 80/20 in favor of soft landing. We believe this correlates well to the general public.
John showed off his PowerPoint skills with a homemade flow chart, showing how businesses and consumers are dependent upon one another, but also upon exogenous factors that hit each differently:
We acknowledge that the American economy has overcome adversity time and time again and has kept growing and growing since our country’s formation. That said, the U.S. also has a 2-8 record on avoiding recessions when the Fed raises interest rates. We don’t doubt that we will keep growing in the long run, although some things do make us question whether we aren’t the Roman Empire circa 4th century A.D.
But we also must acknowledge that the economy has come through a period that has benefited from unprecedented amounts of fiscal stimulus, which has boosted consumer spending, and is almost fully spent. Also, businesses have faced sharp increases in costs, but have successfully passed them on, because the consumer has allowed it. Also, sharply higher interest rates have actually benefited both consumers and companies because interest INCOME on savings has risen markedly faster than interest EXPENSE, because rates on most savings have floated up with the Fed, and many loans are fixed. More and more fixed-rate commercial loans will reset higher every year. Finally, businesses have not laid off employees because they have been so short-staffed, so layoffs have been few. We covered these in our October newsletter.
One chart we could have used is the Leading Economic Indicators (LEI) index; it is an index of 10 variables which do well to presage where the economy will be going. As you can see, LEI typically peaks 1-2 years before a recession (blue columns) begins. Note that the index has declined for 15 straight months:
We also worry about heavily-indebted companies, who either have or will face higher financing costs, which could kick off a wave of bankruptcies, especially in private equity. Also, money supply is decreasing, which has not happened before in modern history, the yield curve is still inverted, and the federal government is running way too big a budget deficit. The government’s interest expense has skyrocketed, and that’s considering the a current average cost of borrowing under 4%. Interest costs were 9% of tax revenues pre-covid; now they are 14%, and soon to be 17%, IF interest rates don’t go up.
It’s probably not a wonder that the government is spending at a rate that might stave off a recession until 2025. Every first-term president that has avoided a recession in the back half of their first term has been re-elected. Every president that has overseen a recession in those 2 years has not been re-elected:
The S&P 500 seems a bit expensive, not pricing in recession, but if you equal-weight all 500 companies, the P/E of 14 is not expensive:
Finally, it’s been a great market for the last 14 years, as shown by the following chart, depicting the annual stock market returns for the previous 10 years at each point:
Historically speaking, periods of above-average returns are typically followed by periods of below-average returns in the next 10. We hit a high point for 2012-2021 at +17%/year, not far from the 1990-99 period. Two bear markets followed in the 2000s, one created by the dot.com bubble, the other by the financial crisis. Even including both, though, stocks were close to breakeven for the decade of the 2000s, and a 60/40 mix of stocks and bonds returned +27%.