The fact that we live at the bottom of a deep gravity well, on the surface of a gas covered planet going around a nuclear fireball 90 million miles away and think this to be normal is obviously some indication of how skewed our perspective tends to be. – Douglas Adams
As most of you know, just like Dad, I am pretty tall. I am 6-foot-8, however my doctor, the practical man that he is, would cough and correct that to 6-foot-7-and ½. Tall people share a kinship in this world, as do all people with specific similarities. I recently saw a joke for tall people posted by a friend on Facebook. It was linked to the very popular Mandalorian series, hinting that there is a certain code shared by tall people, and it was spot on. It said, “As a tall person I cannot offer to reach something on a high shelf for a stranger, yet if they ask me I must oblige. This is the law of the giants.” Tall people get this right away… it is offensive for us to proactively offer that help because of what it insinuates, but if we don’t help when requested we seem mean.
Another kinship tall people have, strangely enough, is with short people. I assume this is because we share the similarity of being outliers. I have had many happy and positive talks with the other outliers, and it always works around to a discussion on perspective. At both far ends of the spectrum we understand each other’s pros and cons, benefits and limitations, and the very different worlds we live in compared to people who aren’t on the fringes of height. We also can share the experience of changing our perspectives to see the world the way others see it. My poor knees and back are put to the test each time I need to bring my point of view down to see what others easily see (the jar of jam in the fridge my wife insists is there… that I can’t see until I bend down a few feet).
The recent news of the possibly 90% effective vaccine that Pfizer is developing has changed my perspective drastically, and from the reaction of the stock market following that news it has changed the perspective of much of the investing population. If you think about it, nothing much has actually changed. Based on what I’ve seen, many of us will still have to wait some time before the vaccine is actually available to us. COVID-19 cases continue to rise, and although Election Day has come and gone the counting and fighting continues.
In other words, the economic, political, health, and social dangers are still present, but… our new perspective has mostly discounted a future with an unconquerable virus that mandates we fully change our lives forever. Normal life as we view it has a future, and businesses will continue to grow, even those we had the least faith in based on that negative alternative future.
The Capital Markets continue to be forward thinking. In the short term they will be at the mercy of our hopes and fears, and the financial news will continue to cater to and amplify that fact. But in the long term, market growth will reflect valuations based on what we as owners can expect from the businesses we own. I wanted to offer a way to view that valuation, especially with an honest accounting of the present headwinds still affecting common stock investment. As Dad has done time and again, I shall turn to the guidance offered by the father of value investing, Benjamin Graham, from his book The Intelligent Investor, which is still considered one of the best books on investing.
Throughout his book, Mr. Graham indicates future stock market performance comes from the sum of a company’s earnings growth, inflation, and dividend yield. This does not include the speculative growth or decline from investors’ preference for stock investments, but it has been a good starting point for conservative market return expectations. So if we fill in today’s estimates of these figures (using a 20 year average of inflation, a long term inflation-adjusted average of earnings growth offered by Robert Shiller, and current S&P 500 dividend yields) we have:
1.70% (Earnings Growth)
+ 2.09% (Inflation)
+ 1.80% (Dividend)
If I add that same 2.09% Inflation figure to our own internally calculated 12 month forward expectations of 4.40% for large cap stocks, we get 6.49%. Note that these estimates continue to be much lower than historical return averages.
So why, despite lower expectations of stock market returns, the current negatives of the virus, the virus’s effect on the economy, social and political worries, and the fact that the markets are “high,” have we been recommending, and continue to recommend, our current equity allocation? Most companies of the S&P 500 have finished reporting their third quarter earnings, and 89% have beaten analyst estimates. There continue to be record levels of “cash on the sidelines” in both investor savings accounts and corporate coffers. Unemployment numbers, as well as new hire numbers, continue to be favorable, a stimulus plan continues to be likely, and the Federal Reserve continues to support businesses. The biggest policy threats from the new administration to corporate earnings seem much less likely with the party mixes in the House and the Senate. And all that cash on the sidelines either continues to earn 0.00% in the bank, or earns historical low rates in fixed income products, with 1-Year Treasuries paying 0.12% and 10-Year Treasuries paying their most recent high of 0.98%.
Although market volatility will continue with the current uncertainties, the tradeoff of the risk and reward between company ownership versus lending our savings at historically low rates guides us to continue to build our current common stock allocations to 70 - 80%, with new purchases as they become available and pass muster. If shorter term, risk-free rates (Certificates of Deposit, U.S. Treasuries) see any advance, we will allocate a portion of our cash to them, but until then our current cash level will be our diversification for market volatility, as well as our opportunity for company purchases.
We have the holidays coming up, but with the Coronavirus cases continuing to climb, it has made family gathering planning much more difficult. There has been a recent flurry of messages in my “Family Group” thread on my phone that indicates we are probably not doing a big group dinner for Thanksgiving. These scenarios are obviously saddening, but I’m thankful for my sisters (Libby and Andrea) for making sure the conversation is coordinated, and everyone’s wishes and concerns are being accounted for. I’m thankful that the sadness we may all be feeling is actually a verification of the love we all have for one another, and I’m thankful in knowing we are still all in touch, talking, planning, and keeping each other in mind.
I will love the light for it shows me the way, yet I will endure the darkness for it shows me the stars. – Og Mandino
Happy Thanksgiving to you all. Our best wishes to you and your families,
Kendall J. Anderson, CFA, Founder
Justin T. Anderson, President