“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold.” – Warren Buffett
From an investor’s perspective, 2018 was a challenging year that began with a strong first half, only to encounter a sharp reversal and decline. Looking back to the start of 2018, if we had known that we would end the year with no major military conflicts, a major tax cut, a revised trade deal with Canada and Mexico, 20%+ corporate earnings growth and unemployment at 3.7%, any rational investor would have predicted a strong market for 2018. The reality is that with the Republicans winning the White House in 2016 while already holding a majority of votes in The House and The Senate, the market expected legislation favorable to businesses and lower taxes. Expectations drove the market gains we saw throughout 2016 and 2017. The volatility we are seeing now….is based on investor expectations (and fears) for the year ahead.
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch
We are almost 10 years into a bull market birthed out of The Financial Crisis, throughout which, economists have described the stock market as climbing a “wall of worry”. The market continues to rise, but no one believes that it can continue. I am confident that at some point we will experience a correction. I am also confident that, many years from now, the companies we own will be much more valuable than they are today.
In my last post, I discussed the macro issues and narratives driving the economy. Market volatility has continued and, in addition to an extended trade war, US markets are now also concerned with rising interest rates, creeping inflation, and an inverting yield curve. There will always be news that creates market concern, but it is usually something unforeseen that impacts investors the most. And for that reason, it makes sense to dedicate this post to detailing our investment strategy and process, which emphasizes understanding the individual companies rather than the broader economy. The investment process focuses on investing in outstanding companies at reasonable prices and reasonable companies at outstanding prices. If we are invested in great companies and buy at great prices, then these investments will inevitably withstand any storms, and our investments will prove profitable.
“Volatility scares enough people out of the market to generate superior returns for those who stay in.”
– Jeremy Siegel, Professor of Finance at The Wharton School
The year has started with volatility that we haven’t seen in the last two years, and it continues as I write this letter. There are two primary narratives driving current markets:
- A possible China/global trade war and,
- A broader technology stock selloff due to backlash over privacy/data lapses, and concerns over government regulation of the largest tech companies.
I will spend some time discussing both topics.
“You’ve got to study all the greats. You’ve got to learn what made them successful and what made them unsuccessful.”
– Michael Jackson encouraging Kobe Bryant to learn from other masters of their craft.
The year ended with all eyes focused on Tax Reform. In our September letter, we discussed the possible outcomes if the White House Administration was successful (or not) in their tax reform pursuits. Less than three months later, the administration signed into law a plan expected to reduce taxes for many Americans and provide a tax holiday for corporations to repatriate overseas cash. Market strategists estimate that the tax plan will fuel corporate earnings by 7% to 9% and that these expected increases are not fully reflected in current stock prices. Roughly translated, barring unforeseen events, many believe that more stock gains are expected for 2018.
How can we make sure that our portfolios not only participate in these gains, but also exceed market returns for 2018 and years to come?
“Love supersedes all armies.” – Dick Gregory
The market continues to benefit from positive investor enthusiasm fueled by a combination of factors:
- Strong corporate earnings performance for the first half of the year.
- A weaker dollar has made it easier for U.S. companies to sell their products overseas.
- U.S. wages have improved enough to encourage consumer spending.
- Interest rates remain low, providing continued sources of borrowing capital, and
- Earnings reports for the September quarter are expected to be positive.
On the policy front, the White House has placed the Healthcare initiative on the backburner to fully focus on tax reform which will be less likely to accentuate party divisions and, if approved, will benefit both large and small companies. RBC Capital Markets estimates that a drop in corporate tax rates from their current effective average rate of 27% down to 20% would add a proportional 7% to per share earnings. Smaller companies, which tend to pay a higher effective tax rate, would benefit even more from the tax cut.
With all of this good news, where can things go wrong?
“Stocks aren’t lottery tickets. There’s a company attached to every share.” – Peter Lynch
The big news of the quarter was the announcement that Amazon intends to purchase Whole Foods for $13.4B in a deal that will extend the online shopping mall into a bricks and mortar merchant with more than 460 physical locations in the US, Canada and Great Britain. What does this do for the company? Won’t this turn Amazon into one of its outdated, old-line competitors?
“In any sort of contest – financial, mental or physical – it’s an enormous advantage to have opponents who have been taught that it’s useless to even try” – Warren Buffet
Spring has arrived, and 2017 has continued with the positive sentiment that closed 2016. U.S. stocks have done very well with the S&P 500 index up over 6% year-to-date. This positive movement is largely the result of continued expectations that the new President will implement business-friendly tax and trade policies that will further boost corporate earnings.
In the December quarter, 65% of companies in the S&P 500 beat their earnings targets and had an average earnings growth rate of 4.9%. This is the first time the index has seen a year-over-year growth in earnings for two consecutive quarters since March 2015. More good news is expected in the coming quarters, but investors are now increasingly beginning to wonder if the stock market is “overvalued” and “are we due” for a correction or crash?
“In the struggle for survival, the fittest win out at the expense of their rivals because they succeed in adapting themselves best to their environment” – Charles Darwin
2016 ended exactly how we predicted…..or perhaps the opposite of that. Election results contradicted most polls, and the market’s reaction to the Republican win was not the Armageddon that I expected. In fact, the Dow, Nasdaq and S&P indexes all improved more than 2.5% from the election to year-end. Benjamin Graham, the man considered to be the father of value investing, taught that “stocks aren’t pieces of paper or lottery tickets; they are units of ownership in real businesses whose underlying value does not change
Richie Capital Group specializes in discretionary investment services for Institutions and Individual Investors. Our investment goal is to maximize client returns over time through an established investment process. We invest money on behalf of our clients and typically do not focus on providing individual comprehensive financial advisory services. However, to bring in clients over the past year, we have gladly performed these services for many who have asked. In this process, we have gained greater insights into the broader world of Financial Advisory Services (Brokers, Investment Advisors, and Wealth Management firms). There are many outstanding companies providing advisory services. But in most other cases, we have come to the conclusion that…. they may not be working in your best interests.