Hope Springs Eternal
This spring marks the 15-year anniversary when the dot-com bubble of the 1990s began to burst. The collapse eventually led to a brutal 78 percent decline in the technology-heavy NASDAQ stock index and the demise of many now infamous companies such as Pets.com, whose sock puppet enjoyed a brief career in television commercials.
Market highs like we are currently experiencing are often viewed as important milestones, conjuring up apprehension and healthy skepticism on the part of investors. We believe the present-day market is a reflection of today’s battle-scarred investors who are cautiously growing in confidence as the economic world improves. These investors are composed of equal parts workman-like persistence and humble recognition of past downturns.
On Main Street there is talk, or at least headline-grabbing surveys, that the majority of people no longer believe in the proverbial American Dream. Yet, along with the stock market, household wealth also recently hit a new all-time high.
And, 2014 was the best year for job creation since the good old days of 1999 (when the Federal Government ran a budget surplus and ‘that Internet thing’ was going to be huge)!
How do we reconcile our lingering economic pessimism with the un-abashedly positive financial statistics? Increasing economic inequality among Americans may play a factor, but stocks don’t have a conscience or a heart to care about equality. Stocks primarily focus on profits.
However, you could make the argument that the U.S. is operating below its full potential. While corporate profit margins are higher than ever, median family income is roughly flat today versus 15 years ago. On the bright side, studies show that corporate earnings growth typically accelerates in the middle stage of a bull market when wage growth also picks up, a point which we believe the economy is approaching. With unemployment at 5.5 percent and wages rising, particularly for highly skilled labor, the economy may be approaching a sweet spot where both wages and profits improve, making everyone better off.
To evaluate the current investing environment, it helps to start by recognizing how vastly different today’s market is compared to the infamous early 2000 peak.
Simply considering these numbers, two key observations are clear. First, things are fundamentally much better for U.S. companies today: there are more customers (population) and more people working; economic output (GDP) is higher; companies are earning significantly higher profits; more of those profits are coming from places outside the U.S.; and inflation is very low. In fact, for consumers, inflation is temporarily non-existent due to the recent steep decline in energy prices. While lower energy prices may disproportionately hurt Oklahoma’s economy, world-wide they are helping pad consumer wallets, while also supporting lower bond yields.
Secondly, while far from cheap compared to the 2009 market low, we believe the market’s current valuation as measured by the price-earnings multiple (P/E) for the S&P 500 Index at 18 is reasonable given the current low-inflation environment and the valuation of other investment alternatives. After all, investors must put their money in something other than cash or low-interest bonds if they intend to at least keep up with inflation over the long run.
Comparing investment alternatives in yield terms, the 5.5 percent earnings yield for the S&P 500 is appealing relative to the 4.2 percent yield earned for loaning money to the average large U.S. company (long-maturity, investment-grade corporate bond index) or just 2.5 percent earned for loaning the U.S government money for 30 years. Indeed, if time is on your side and the higher volatility of stocks versus bonds is considered acceptable, it appears wise these days to invest in stocks for the long-term. This is in contrast to the relatively unappealing 3.3 percent earnings yield of the S&P 500 that was apparent in early 2000.
LET’S GET PHILOSOPHICAL
Numbers and cold-hearted analysis make up one perspective, but we often hear from clients that things “still aren’t very good” economically speaking, a reflection of the stagnant median incomes mentioned previously. Perhaps a more bold reason to invest in stocks is that today’s new market highs are anticipating continued growth and prosperity beyond what the average American is feeling at the moment. Markets attempt to foretell the future, and this wouldn’t be the first time in history stocks have rallied in anticipation of better days ahead.
Protracted bear markets during the Great Depression of the 1930s and the stagnation of the late 1960s and 1970s each led to two approximately 20-year-long bull markets whose returns made up for lost time. The recent recovery from the dual economic crises of the 2000s were similarly born of pessimism and struggle, fueled by fundamental economic improvement and pushed higher by investor optimism. Intriguingly, the timing of each bull market cycle roughly corresponds with the handoff from one generation’s dominance of the economy to another generation’s zeal for crafting the world to fit its own values.
In the first half of the 20th century, hardship of the Great Depression and World War II gave way to the baby boom era, stability, and suburbia, coinciding with a 20-year stock market advance from the early 1940s to the mid-1960s. Then, in the late ‘60s through ‘70s, stagnation in politics (Watergate), in the military (Vietnam), and the economy (energy crisis, inflation) coincided with a sideways bear market, but ultimately gave way to the ambitions of the Baby Boomers.
This rise in prominence of the Baby Boomers overlapped with an 18-year bull market advance throughout the 1980s and 1990s. However, the dot-com bubble of the 1990s and the housing bubble of the 2000s created another sideways market episode from 2000 until new highs were first reached in 2013.
Likewise today, as damage from the most recent bubbles is repaired, wounds of the Afghan and Iraq wars are healed, and political lethargy is hopefully overcome, the Millennial generation may lead the next prolonged bull market. This will play out as Baby Boomers retire and Millennials hit their early to mid-life stride, eclipsing Baby Boomers and Generation X in sheer size and influence.
Lifestyle and technology trends inspired by Generation X are now fully embraced by Millennials. New technology networks such as Uber, Kickstarter, and Khan Academy are good examples of organizations at the forefront shaping our future. Respectively, they are democratizing personal transportation, fundraising campaigns, and high quality education. Other technology trends such as smart personal devices like Fitbit and the Apple Watch could be instigators of an incentive-driven healthcare system in the future. And on the lifestyle front, the U.S. homeownership rate, which has been falling since 2004, may actually improve future economic growth due to increased worker mobility.
While some of today’s trends will be fleeting, many will generate new opportunities and create wealth in the process. The benefit to investors from advancements is more apparent than ever. It may be easy to look at immediate financial struggles and focus on past economic downturns, but beware that market history is not on the side of those who doubt human creativity to overcome obstacles. Rather, history tells us that it is the optimists who triumph in the long-term.