2018 has been a year. Our government quickly and efficiently quashed the romaine lettuce E. coli outbreak but was unwilling to introduce gun control legislation. So, our salads are safe, but our children remain at risk. Muller’s investigation continues to slay, and legislative chaos is the capstone of the Trump administrative era. US Customs and border patrol separates asylum-seekers from their children. 126 badass women are elected to serve in Congress. Tweets continue to destroy billions in market capitalization. The rise of antisemitism and calling the police for living while black. California fires and our earth’s imminent climate crisis. Trade war. Government shutdown (well, I can almost cheer for that).
2018 was hard.
The markets are making headlines again. This time, rather than technology stocks achieving gravity-defying highs, such as Apple’s trillion-dollar market cap late this summer, we’re biting our collective knuckles as “peak everything” reverberates through our economic hallways.
While we can reasonably debate the ideal interest rate environment or the health of our consumerist culture, markets are anything but reasonable. Despite, or perhaps because of, an absurdly unconventional political climate combined with a decade of artificially-low interest rates, US equity markets have achieved multiples not seen since 1999-2000.
So, if we have in fact reached the peak of our markets’ earnings and profits growth, does that mean recession is around the corner?
In short, no. Here’s a chart:
S&P 500 earnings per share since 1870
(inflation adjusted, in Nov 2018 dollars, chart from multpl.com)
While we may have achieved “peak earnings,” the chart illustrates that over time, our economy continues to achieve higher highs. This is why we play the long game.
Corporate earnings growth (which is the measurement, in %, of year over year growth), economic growth (Gross Domestic Product or GDP, measuring how much the U.S. produces in goods and services) and profit margins (the ratio of profits earned to total sales) have pulled back from recent highs. Some economists believe that an economic peak can foretell a coming recession. Obviously, the outcome is far more complex than a few simple metrics. We believe that we will experience continued earnings growth – but not at the clip we’ve been achieving over the past couple of years. However, GDP growth is still clocking in at a 3.5% annual rate in the third quarter. Hardly a recessionary number.
The Federal Reserve raised interest rates on Tuesday by ¼ point but many investors hoped that, given the macro economic weakness, the Fed might hold off on the hike. Powell, the Fed chair, was essentially damned no matter what action he took. If he raised rates, as was planned, the risk to the markets was significant given recent weakness due to Trump tariffs and an impending trade war. But if Powell backed off and did not raise rates (something we like to call ‘Unch’ or unchanged) he might be seen as kowtowing to Trump, who recently demanded (in a tweet of course) that the Fed ease back on rate hikes.
Keep in mind that when the Federal Reserve raises rates, they are signaling that the economy is strong, and lending should be more expensive.
Investors are more than a little conditioned to believe that there’s a mega grizzly bear, lurking somewhere within our global financial system, particularly during times of extreme market volatility such as these. One big reason we have held abnormally high levels of cash (more than 10-15%) in our Divine accounts is because we want to be prepared for unreasonable markets and take advantage of ‘flash sales’ when they hit. Over the long term – which is where we set our sights- markets recover and the overall trend continues it’s march upward.
When we take stock of 2018, let us not forget the GOOD news: our dividend growth strategy of owning high-cash-flow securities that pay dividends that buy more securities, generating yet more cash is the zenith of long term investing.
Market meltdowns are inevitable. The 18-point swing in the Dow and S&P this year (from up 10% to down 8%) was a wild one. There will be more volatility. There will also be an abundance of blessings, friendships, laughter and love to be grateful for in the coming years. I look forward to that, and to continuing to build positions in iconic issuers for long-term dividend growth.
Sending much love to you and your families,
Dani and Val
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