Glass shattered, in slow motion, when Ella Fitzgerald reached a sufficiently high note during a 1971 television commercial. Her recorded voice, subsequently played back on audio cassette, replicated the results, giving birth to a classic advertising slogan, “Is it real or is it Memorex?” (1)
This note will focus on the identification of what we deem “real” in an increasingly distorted atmosphere.
We only care about your portfolio and have zero political agenda here. The financial markets are not red or blue, but pure green. (2) Predictably, CNBC and Investor’s Business Daily devote considerable attention to the pending Presidential election. Their business model, unlike ours, is supported by advertisers and requires excessive focus on short term results. We liken this to the sports betting room in a Las Vegas casino where bettors are seduced on the outcome of such inane events as the first touchdown or the most fumbles, details long forgotten when the season ends and the champion is crowned.
If we were willing to be recklessly indulgent, we could highlight aspirational differences between the two candidates, but, we have no intention of making investment decisions on the basis of who might win the Presidential election because:
The Fed concluded their September open-market meeting by once again lowering GDP projections, down to 1.8%, for the fourth quarter. (5) Why does the economy continue to sputter along at about one-half of the historical growth rate? (6) Consider three prodigious sources of economic growth in the U.S. since World War II.
The common denominator? None seem likely to repeat. U.S. debt, at 100% of GDP, can no longer be expanded without restricting future growth prospects even further. Women are already fully represented in the work force and population growth in the U.S. has slowed to less than 1% per year since 2000. (10)
Despite absolute polarity (11) and the cold facts regarding the budget deficit, both Presidential candidates seem likely to push for fiscal stimulus. (12) Infrastructure, already outperforming this year, seems like a reasonable spending target.
Janet Yellen’s term as Fed Chair does not expire until 2018, leaving her expansion policies likely unaffected by the election. Consider the impact of rock bottom interest rates:
No wonder the financial markets cower whenever the Fed meets to discuss the possibility of raising rates. Paradoxically, low interest rates, pushing down investment returns, have caused individuals to save more for retirement, and to spend less, restricting economic activity. (13)
Near term, expect more volatility in advance of the election, reflecting the market’s disdain for uncertainty. Longer term, curtail expectations. Between 1973 and 2015 large cap U.S. stocks returned about 10%, of which about 3% came from dividends and about 7% from growth. (14) We see lower contributions from each component on the basis of:
The combination of slower growth and lower multiples should culminate in lower equity returns than the historical norm. How much lower depends on a multitude of variables.
Investment returns mean nothing in isolation. Subtract inflation from reported returns and an investor (ignoring taxes and expenses), can determine their “real rate of return”. The feel good 10% returns, between 1973 and 2015 were accompanied by 4% annual inflation. (17) Annual real returns were therefore 6% (10% minus 4%).
Over the past 10 years, a period that included the infamous 2008 meltdown, the S & P 500 returned only 7.3% per year. However, inflation of only 1.9% per year brought a still respectable 5.4% “real return”. Seen through the prism of the current inflation projection of 1.5% per year, respectable real returns could be achieved with reported returns of around 6.5 – 7.0%. (18)
Some of you may recall the less famous, but equally effective Memorex commercial captured in the picture below.
The recorded music sounds so real, it “blows away” the listener. During this election, the 35th such since the beginning of the market graph noted above, we will do our best to keep you from getting blown away. Our long game strategy includes:
Instead of risking your capital on who makes the first fumble, we remain firmly focused on bringing you home the trophy – keeping you on track, with a suitably comfortable ride, to reach your financial destination.
1. Technically the slogan referred to “live” rather than “real” so please accept our use of poetic license.
2. Paraphrased from Jonathan Golub, market strategist at RBC Capital in speech given at IMCA conference we attended on September 29, 2016 in Chicago.
3. Using data provided by Standard & Poor’s
4. The Leuthold Group; 2012
5. Bloomberg; September 21, 2016. GDP is gross domestic product, a measure of total economic activity.
6. GDP is published by the Bureau of Economic Analysis. Calculations by WCF.
7. All GDP data sourced from Int’l Monetary Fund.
8. Federal Reserve Bank of St. Louis
9. Department of Labor
11. A technical recording term describing a clean reproduction of music. Obvious double meaning.
12. The current budget deficit, by the government’s own estimates, is projected to grow from $438 million this year to $1.2 trillion by 2026. Congressional Budget Office. CBO.COM. Report dated August 2016
13. From speech by Vikram Mansharamani of Yale University given at IMCA conference we attended on September 29, 2016 in Chicago.
14. Using data provided by Standard & Poor’s.
15. Federal Reserve Bank of St. Louis citing Bureau of Economic Analysis (www.bea.gov/national) This Time is Different by Carmen M. Reinhardt & Kenneth S. Rogoff; 2009 accurately predicted slower GDP growth that has failed to reach even 5% per year in the past 10 years.
16. According to FactSet, the S & P 500 trades for 16.7 times the forward 12 month earnings estimates and that compares to a historical multiple of 14.3.
17. Using Consumer Price Index, US Bureau of Labor Statistics; Thompson Data
18. The current yield on 10-Year Treasury Notes (1.54%) minus the current yield on 10-Year TIPs (Treasury Inflation Protected Securities) (.08%) leaves an implied 1.46% rate of inflation according to the financial markets. This has historically been a good source of inflation projections.
|President (term)||S&P 500 Price Return*|
|Franklin D. Roosevelt (1st term)||162.0 %|
|Bill Clinton (1st term)||79.2 %|
|Barack Obama (through 9/6/2012)||77.8 %|
|Bill Clinton (2nd term)||72.9 %|
|Dwight D. Eisenhower (1st term)||69.9 %|
|Harry S. Truman (full term)||68.6 %|
|Ronald Reagan (2nd term)||63.6 %|
|George H. W. Bush||51.2 %|
|Dwight D. Eisenhower (2nd term)||35.0 %|
|Ronald Reagan (1st term)||33.1 %|
|Jimmy Carter||27.9 %|
|Franklin D. Roosevelt (3rd term)||27.5 %|
|Gerald Ford (partial term)||27.3 %|
|Lyndon B. Johnson (partial term)||24.4 %|
|Lyndon B. Johnson (full term)||17.4 %|
|Richard M. Nixon (1st term)||16.2 %|
|John F. Kennedy (partial term)||16.1 %|
|Harry S. Truman (partial term)||10.3 %|
|Franklin D. Roosevelt (4th term ‐ partial)||5.2 %|
|George W. Bush (1st term)||-12.5%|
|George W. Bush (2nd term)||-31.5%|
|Richard M. Nixon (partial term)||-31.6%|
|Franklin D. Roosevelt (2nd term)||-41.3%|
|Herbert C. Hoover||-73.3%|
|Median For Democrats:||27.5%|
|Median For Republicans:||27.3%|
|Median For All Terms:||27.4%|
* Return measured from inauguration days, except for those ended by death or resignation