Fall 2013 Seminar Recap
|Thanks to all who joined us at the Fort Wayne Museum of Art for our annual seminar on September 20. Investments, food, drinks, and Dale Chihuly were the highlights of the evening. We made mention that Monarch is now in its 20th year, having been founded in August, 1994. Next August, we’ll host a grand celebration, but of course we’ll make you listen to Dave dissect the yield curve and John breeze through a 25-slide Powerpoint presentation first. Don’t mess with tradition.
At the seminar, we looked back 5 years to the darkest days of the financial crisis in September and October, 2008. It’s nothing short of amazing what’s changed in 5 years (let alone 20 years). Dave looked at the Fed’s balance sheet, today compared with the halcyon days, pre-financial crisis:
Today’s balance of $3.6 trillion makes the Fed of 2007 look the size of a credit union. Dave explained the process by which the Fed is buying Treasury bonds and mortgage-backed securities from banks, who leave the proceeds on deposit at the Fed. If/when the Fed ever decides to stop buying bonds and (gasp!) even sell them, they would likely unwind the process by selling the bonds back to the banks, thus shrinking the Fed’s balance sheet.
Also in honor of the financial crisis’ 5th anniversary, George presented the results of a research study we recently undertook. We compare the past 5 years (2008-13) to the previous 5 years in terms of how Monarch’s core stocks have been able to grow sales, sales per share, earnings per share, and dividends:
One overarching conclusion is that even high-quality companies aren’t immune to this moribund economy. BUT, despite the financial crisis and the sloggy recovery, they have not only persevered, but grown. Throw in the headwind of all the bank stock (and GE) dividend cuts in 2009, and that 7.1% growth rate in dividends is pretty darn good. In other words, your payout is 40% higher now than it was BEFORE the financial crisis. Growth rates for the overall market, as represented by the S&P 500, are nearly all slower. If you wish to dive further into this, our quarterly newsletter, mailed today (October 1), covers it extensively.
Finally, John attempted to put the very strong stock market into context. On some level, we all are probably a tad more nervous than we were just a couple years ago, given how well stocks have performed. BUT, it should be noted that the U.S. economy was hitting new highs in 2010 or 2011, depending upon your metric of choice, as were corporate profits and dividends. Government revenues even hit a new high in late 2012, in spite of the cut in the payroll tax rate from 6.2% to 4.2%. But the stock market took until April, 2013, to finally move past the highs of 2007. What’s the deal?
We’ve said this so many times it’s probably getting old, but this is the most hated bull market ever in the history of bull markets. So many individuals have remained on the sidelines, watching it go up and up. Hedge funds largely remain on the sidelines. Investment managers with more cash than they’d like keep waiting for the ephemeral correction to come. Even the President probably hates it, because it’s creating a lot more fat-cat millionaires.
Nobody is immune in this. We showed 3 sentiment indicators, from 3 different constituencies of the investment world. The first is from Wall Street strategists. The “Sell Side Indicator” tabulates how much of an allocation the strategists recommend for stocks. The lower the recommendation to stocks, the less bullish they are, and the lower the position on the line below:
As you would expect, early 2009 marked a low point for the strategists’ enthusiasm for stocks, given that it was an ugly market. But it was also the best time to buy stocks since 1980. Their bullishness rose for 2 years until late 2011, when they turned more bearish than they ever have. Since 2012, the bearishness has receded somewhat, but the line is still at a fairly low level.
What do you do with this chart? You do the exact opposite of what Wall Street recommends. The lower the line, the better off you’ll be owning stocks. It has a statistically significant correlation of 27% for predicting market performance over the next 1-2 years. Yes, Wall Street strategists are purported to be smart, well-read folks, but the problem is that they all represent a sort of slush pot of conformity with each other and the rest of the investing world. When the mood of everyone around them turns bearish, they can’t help but join the crowd.
While that sounds like we’re throwing stones, our industry isn’t much better. The “II Bull/Bear Survey” simply surveys investment managers to see how bullish or bearish they say they are. The survey results are on the bottom half of the chart; the top half shows the S&P 500.
II Bull/Bear Survey
Again, when the situation seems the ugliest, like in the midst of the financial crisis in late 2008, or in late 2011, in the wake of the near-government default and downgrade of the U.S. debt rating from AAA, sentiment is naturally the most bearish. But those are also 2 times one should’ve been buying stocks hand over fist. So again, this is another contrarian indicator, meaning you should do the opposite of the pros. Where are we now? Pretty much right in the middle of the historical average.
Finally, the much-ballyhooed mutual fund flows chart (below). This shows the cumulative amount of investor money that’s gone into bond funds (bold dark line) since 2009 and that which has gone into stock funds (dashed line). Flows into international stocks are on the diamond line.
History shows that this indicator is even better than the first two at predicting where the market will be going. In 1999 and early 2000, at the peak of the dot.com bubble, investors were looking for change under their sofa cushions to throw into stocks, and selling bond funds to boot. Instead, the best trade one could have made then was to sell stocks and buy bonds.
The opposite has been taking place since the financial crisis: nobody wants stocks, but they love bonds. Until they don’t, that is. Since interest rates have shot up by more than 1% in just the last 4 months, they’ve started to buy stocks finally, and sell bonds. But the amounts have been so infinitesimally small that there doesn’t appear to be any movement up in the stock line, and the bond line has hardly undone any of the inflows of the last 4 ½ years.
These 3 indicators tell a story that sentiment is, at best, neutral for stocks. On a valuation basis, stocks are still way cheaper than bonds, even after yields have risen and stocks have risen. We continue to look out for dangerous valuations on our core stocks. The P/Es on almost all of our core stocks are still so much lower than they were in the belly of the last cycle, 2004-07. A couple stocks are approaching those levels. Although we don’t view those valuations as ceilings, it will require us to ask whether the future earnings growth is enough to justify the valuation. For now, though, this final chart shows the highest and lowest P/Es for each year, for all the core stocks averaged together. Though it’s hard to believe, these P/Es have hardly budged from 2012 to 2013:
It’s been roughly 3 years now of P/E’s in the 13-17 range. If earnings can go up as fast as stocks, that would be nice. But if stocks want to go up more, so be it….in the 2004-07 period, the range was 17-30, so we’re still a long way from the ceiling.
No doubt we are all keeping an eye on the charade in Washington that passes for governing. It’s hard to believe that a compromise could come out of the “standoff,” but it is interesting to see the market’s reaction to the failed negotiations….the Dow is up 62 points today. We have witnessed the stock market reacting less and less to bad news since the bull market began in 2009. This is good news, in that we endure fewer of those corrections, but also bad news in that we must acknowledge that we’ve climbed a long way up the wall of worry.
When the government last endured a shutdown, in late 1995, the market fell about 5% before and during the early phase of the shutdown, then was off to the races following it. This time, the S&P 500 has dropped 2.7% since its September 18 high. Pretty similar.