At the risk of talking about the weather too much, it is mandatory that we mention the foreshadowing to last Tuesday’s lunch, if only on account of the high number of customers who brought their invitation to lunch to blame us for the snow. Our invitation, mailed over 1 month ago, referenced that this was the final lunch of the “winter” series, and “hopefully the winter part is a joke.” Our follow-up email invite: “Lord help us if it’s still snowing then.” He does have a sense of humor!
The ArtsLab, aka the Black Box Theater, made for a unique, edgy venue. The dark floors and walls, minimalist decor, and stage lights made for a different feel than our other seminars. But this was all a facade, as we still think there’s a clear path for stocks over the next couple years.
Noel warmed up the crowd with a cartoon, seeking any and all interpretations thereof which would be applicable to the financial world. George obliged by offering that the caveman was chasing the bull market, while still fearful of a bear market, which may have been so astute that no one else offered an opinion. You can see the whole slide deck here.
George also mentioned the results of a research study he just conducted, which found nearly half of our core stocks saw their sales and earnings either rise, or drop less than 5%, during the crippling recession of 2008-09. Just a reminder that the values of reliability and quality are the most prominent in bear markets. If you’re a long-term investor, you should expect to see many of those bear markets in your holding period, so you need to give yourself a gut check before it happens. If you think a riskier stock is likely to decline more than the market in a bear market (by definition, it will do that), you need to have an especially strong conviction to hold onto it through the ugliness, or have a plan to only hold the stock temporarily. Some sectors that came up at the lunch that could apply to this include the new breed of tech companies which aren’t profitable, biotechs trading at high multiples, and independent oil producers.
Dave showed 4 slides, the first of which was a study of the core stocks’ dividends over the last 11 years, which is slide #5. If you put a million bucks into the core stocks on 12/31/02, admittedly a low point for the market two bear markets ago, you’d have about $2.2 million now. But more impressively, your dividends would have risen from $15,877 to $54,859 by the end of 2013. This was a follow-on to the dividend study Dave conducted last year, which showed that the core stock dividends tripled in the 10 years of 2003-12. The feedback out of this finding from our customers was electric, with more than a twinge of disbelief. Nonetheless, from that high level of 2012, dividends actually rose 17% in 2013! Most companies raised their dividends in the 7-10% range, but there were a few who dramatically raised their payouts, namely Cisco (78%), Home Depot (35%), Wells Fargo (31%), and Stryker (25%). In addition, EMC and Zimmer initiated new dividends. The average yield is 2.5%, not bad when you consider it was 1.5% on 12/31/02, and wasn’t much higher in the throes of the bear market on 12/31/08 (2.9%). We still expect dividend growth to exceed earnings growth in the coming years. 2014 has gotten off to a strong start, with big increases from Abbott (57%) and 3M (35%).
The next slide (#6) demonstrates that every recession and ugly bear market was preceded by an inverted yield curve, where short-term interest rates are higher than long-term rates. Obviously, with short rates near 0%, that ain’t happening anytime soon. BUT, the following two slides make us wary that mid-term election years, like 2014, are notoriously volatile. The average correction in the last 21 mid-term years (2010, 2006, 2002…back to 1930) is 22%. And it usually comes in the summer or fall. But the 1-year gain that follows averages 35%! If history holds, buckle your seat belts this year.
The rest of the slides are from the Q&A session. Investor sentiment is mixed, with individual investors now more bearish than bullish, a turnaround from the beginning of 2014. The pros, however, are more complacent, with bulls a little above normal, and bears almost nonexistent. Value stocks started outperforming growth stocks in early March, and have continued to do so since then. We were asked if P/Es of 20 or more on some of our core stocks were ringing any alarm bells. The answer is yes, but in these few isolated cases, they are merely returning to the average valuations of the last cycle, in 2004-07. ADP is the exception, now trading at a slightly higher P/E than in that period. This is partly due to its scarce AAA pedigree, but also because there are 3 good catalysts that will keep the P/E propped up until earnings growth accelerates from its current 9-10% rate (interest rates eventually reverting to more normal levels, a good job outlook, and its nascent HCM cloud software business). There was interest in seeing the actual list of core stocks, so we put up a slide of their performance last year. The ulterior motive was certainly not to boast about the incredible 2013 returns, but to compare them to year-to-date 2014 returns. So far, the relative losers from 2013 have been winners in 2014 (Merck, EMC, McDonalds, Cisco, Intel), while some of the best performers in 2013 (Franklin, Lake City, ADP, 3M, Emerson) have lagged in 2014. Finally, a chart that we intended to use, but ran out of time, shows the breadth of performance in the S&P 500 in 2013. More than 400 of the 500 stocks in the S&P rose last year (it was actually 475–not even close to 400), which puts the year in rare company since 1980: only 6 other times has this happened. Of those 6 years, 3 were the first year of a bull market (1991, 2003, 2009), while the other 3 were in the middle of an economic cycle (1985, 1995, 1997). None were “end-of-cycle” markets. This makes sense because, as markets push into bubble/peak territory, investors tend to crowd into those sectors benefiting the most from the bubble (in the past: oil, tech, mega-caps, real estate, commodities), all the while forgetting what a bear market even is. This is just one more arrow in the quiver which suggests that this bull market has a few more years to go.
We’re thankful to have an inquisitive group of customers, and also thankful that neither Bitcoin nor gold came up! But seriously, if there’s anything you’re curious about, don’t hesitate to ask us.