ORDINARILY NOT SO ORDINARY – Bobbo Jetmundsen
Innovation is again worth mentioning this year. It is remarkable. The pace is fast and the opportunity is large. It might be prudent to expect there to be funding hiccups along the way. Venture capital in terms of dollars has been concentrated in huge bets around AI, then large downstream ideas in defense and robotics. The IPO window has continued to open, and some interesting companies are likely to emerge. A robust IPO ecosystem for the rank-and-file private company is trying to evolve, and the backlog of companies looking for liquidity for their shareholders is quite large.
Inflation is experienced in real time buying groceries, gas and hotel rooms. Deflationary pressures from new technologies and efficiencies offset this to some degree and should become more obvious over time; innovation can be quite deflationary. Still, the purchasing power of the dollar erodes over time, and with the national debt growing, owning assets that help preserve value seems prudent, such as stocks, real estate, gold/silver and some crypto-related ideas.
Housing is trying to find footing. We learned in 2008 that people buying homes they can’t afford leads to the wrong outcome. That changed. Median inflation-adjusted home prices are at near record levels. Those might change. When you have a shortage of something, prices are usually inflated. Median home prices have doubled versus the rate of increase in income since late ‘60s. Higher income levels help affordability. That should change. Houses are larger today, so keep that in mind. Note: women 30-34 record a higher birth rate than those aged 25-29 and the lack of good housing for younger people might be a reason. Gals give birth to 1.6 babies now, but you need 2.1 to replace those going to their reward.
Markets are near all-time highs, and the bubble talk continues. Measured from the 2000 bubble top, returns look ordinary. The S&P 500 market-capitalization-weighted index has earned about 6.3% a year, right in line with its long-term average. But measure just the last ten years and the picture changes: the S&P has returned about 13% a year, similar to what the DJIA did in the ten years before the 1929 crash. Leverage is far lower today than in the 1920s, but history suggests that strong decades borrow from the next one. Valuations tell that investors are paying up for a handful of the largest companies. The average stock is far more reasonably priced as we see by looking at the equal-weighted index.
The P/E valuations are another story. Investors are paying about 26x today for every dollar the S&P 500 earned over the past year, versus a long-run average of about 16x. That is excessive, but that premium sits mostly in the largest companies. Give every company equal weight and the price drops to about 20x, which is far more reasonable but still high.
A tidbit: stock buybacks really took off in 1982, when the SEC adopted a rule that gave companies a safe harbor to repurchase their own shares. Before then, companies just paid dividends. S&P 500 companies now buy back close to $1 trillion of their own stock a year, a record in dollars. But because the market has grown so large, that spending retires only about 2% of its value annually,
half the rate of 2018. Buybacks often peak near market tops, as they did in 2007, but today’s pace does not confirm a bubble either. Be aware that employee stock options often dilute the effect of buybacks on total shares outstanding.
Cash balances look large in dollar terms but are historically low as a share of assets, for both institutions and individuals. Margin debt, money borrowed to buy stocks, hit a record $1.5 trillion this summer. Relative to the size of the market, it’s no higher than at past peaks, but the pace is telling: it grew about 49% over the past year while stocks rose about 21%, the widest gap since 2007. Borrowed money cuts both ways. In the last two major bear markets, margin debt fell by more than half as margin calls forced investors to sell, which only fed the decline. Measured against the market’s value, it barely changes in a selloff, since the borrowing and the stocks fall together. That’s exactly why it hurts. Pair that with buybacks: companies are the market’s steadiest buyer today, but they pulled back by roughly three-quarters after 2007. If something breaks, the biggest buyer may step away just as forced sellers arrive. July brought the largest monthly drop in margin debt on record. One month doesn’t make a trend, but it bears watching. These signals are more worrisome, but to counter that, earnings have been strong, and strong earnings are what keep a market climbing its famous ‘wall of worry’; you can read up on that phrase somewhere if it is not familiar to you.
‘Ladies and gentlemen, keep your seatbelts fastened. We plan to stay the course, but turbulence or an air pocket or two might disrupt cabin service.’
