October 23, 2020
I chose this newsletter’s topic in response to the countless inquiries as to what portfolio response is prudent given the perceived extreme uncertainties surrounding the upcoming election.
First, Fusion’s golden rules:
1. All successful investing is goal-focused and planning driven, such that all successful investors are continuously (ALWAYS) acting on a plan;
2. All failed investing is market focused and current events/performance driven, such that all failed investors are continually (episodically) reacting to current events, the markets and short-term performance statistics.
Reacting to one’s perception of election risk by reflecting one’s thoughts/fears in determining portfolio strategy will likely result in a financial error from which one’s wealth and even retirement will likely never recover.
What does our long and rich history suggest? There have been 21 election years since 1936. All but two of them (2012 and 2016) now have prospective 10-year market return histories. A democrat won 11 times and a republican won 10 times. According to Thomson InvestmentView, 18 of the 19 election years with 10-year prospective market return data periods yielded positive results for the S & P 500. The one period that did not was virtually unchanged and began in 2000 with the election of “Dubya.” The highest returning decade was 1988-1997 when George H.W. Bush was elected and $10,000 grew five-fold (annualizing at about 18%) to over $52,000. In sum, of all the 10-year periods beginning with an election year, returns were positive 95% of the time. The average annual return during the democratic
regimes was 10.7% while the average during republican regimes was 10.5%. Moreover, according to research by Capital Group, Strategas, the average annual returns by various party control scenarios were:
1. Unified government whereby the White House, House and Senate were controlled by the same party – the S & P 500 annualized at 10%;
2. Unified Congress with President in other party – the S & P 500 annualized at 7.4%;
3. Split Congress, regardless of White House Control – the S & P 500 annualized at 10.4%.
Hopefully, you are beginning to see the futility of trying to divine who might win the White House and using such speculation attempting to enhance your investment plan. Historically, the 10-year market periods beginning with an election year have been among the most rewarding.
I can hear many now begin to sing that four word death song of the American investor: “THIS TIME IS DIFFERENT,” in response to which I sing my four word refrain: “NO IT IS NOT!”
THE MARKET SEEMS DISCONNECTED FROM THE REAL ECONOMY – CURRENT VALUATIONS DEFY LOGIC
Let’s debunk the myth that the economy and stock market are ever linked, other than over the very long-term. I cite one of the poorest recoveries from a recession in modern history (2009-2012). The economy grew between 1% and 2% annually and unemployment remained over 7%. Assume an investor asked me in June 2009 what I thought the economy would do coming out of the recession and I said that I had a crystal ball, so that I KNEW in advance that it would unfold as it did. Given that prospective economic knowledge, one who assumes a short-term linkage to the market would never have invested in stocks. That four year economic period saw stocks return 14% annually – a 40% premium to long-term average returns. The moral: the economy will not tell us what the stock market will do and it certainly WILL NEVER tell us what it is about to do!
The real question investors must ask instead of asking what moves they should make in response to WHATEVER the concern/catastrophe du jour may be, is: What in the world will “fill in the blank” have to do with my plan 20 years from now, because that and the ten years on either side of that is the focal point of most plans.
WHY IN THIS ARTICLE’S TITLE DO I CALL THE MARKET WILDLY OVERVALUED?
Simply, I am referring to the BOND market. As I write, the 10-year Treasury bond has an income yield of .8%. Receiving $8,000 in annual interest, it will take 125 years to get back $1 million. So, the bond has a price-to-earnings ratio of 125 versus 21 for the S & P 500 based on the 2021 consensus earnings forecast of $165. The dividend yield on the S & P is 1.75% which is over twice the yield of the 10-year bond and 10% more than a 30-year Treasury yield (a condition without precedent). The 25-year average P/E ratio for the S & P is 16.5 while the 25-year average yield for the 10-year Treasury is 4.5%. In that context, stocks appear very attractively valued.
Moreover, dividing 2021 forecast S & P earnings of $165 by its current price level of 3,443 gives us an earning’s yield of 4.85%. In short, the higher the earnings yield, the more earnings per share we get for each dollar invested. The most comparable current Moody’s Corporate Bond index yield is 3.4%. So, the earnings we presently receive from stocks is at a historically large (42%) premium to the bond yield. Historically, the earnings yield and corporate bond yield have been about equal. Many feel the extreme relative attractiveness of stocks over bonds cannot be the whole story. I believe it can, but there is much more!
If you missed the dramatic rebound from March lows, don’t worry, as I believe we are just getting started. We are very likely in the middle of the greatest bull market for generations to come. One of only three secular bull – long term, roughly 20-year runs – in modern history. Please refer to our June 30 newsletter for a detailed explanation of this secular bull market pattern and why we believe we are in one. These market cycles have one thing in common. They have only ended on mass euphoric, greed-based buying into a bubble of historic proportion. Most of us learned this experientially (and often, painfully) in the aftermath of the dotcom bubble at the end of the previous secular bull in 2000.
Investor behavior has been the polar opposite for the majority of the past 11 years (greatest bull market in history). According to Refinitiv/Lipper, Investors have been net sellers of domestic stocks in all but 3 of the past 12 years. Worse, they sold a record $167 billion worth of stocks in 2019 which was the second best performing year in the best bull market in history. This year, having sold domestic stocks to the tune of $198 billion, a new fear-based annual selling record is about to be set. Fund flow data began being collected in 1992!
Such behavior occurs early on in bull markets and nowhere near their impending crescendo. We will certainly see intermittent market declines annually (averaging 15% since 1980) and bear market declines 1 year in 5 or 6 (historically, averaging 30%). The great companies of America and the world will be on special sale…..investors are encouraged to behave accordingly.
Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.
~ Sir John Templeton
As an investor, ask yourself if you feel optimistic or euphoric about the future of stocks right now! Your honest answer will confirm my point.
Happy voting and stay well!
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