“This is the most difficult time to forecast that I have ever experienced in my career.”
– Brian Wesbury, First Trust Chief Economist
Whenever I’m struggling to think of something to include in our letter, and I ask Kendall for ideas, he never fails to remind me “That’s how it was for me every time… I had writer’s block every single time.” Once my complaints get to a certain level, Libby will just lash out with a quick topic and expect me to move on. This time it was, “Don’t you usually do a forecast? Do that.”
So I will do that, but it will be very general, because of the second part of Libby’s proclamation… “Just don’t put all those numbers in it that people don’t understand or get mad at.” She was referring to a time when Kendall published a forecast out five years in advance, using a growth rate that we generate internally. The “public forum” of one of the advisor websites we follow and published to went up in arms. Dad has always been pretty good at stimulating conversation… especially flavorfully critical conversation.
The numbers part - That growth figure, which we’ve been calculating the same way for 20+ years, is showing that large capitalization companies are set at current prices to generate 5.62% for their owners over the next 12 months. When you compare that to the 2-Year Treasury yield of 4.22%, you can see the equity risk premium, or the amount of return that stocks are offering over a risk-free rate of return (treasuries). The equity risk premium is much smaller than it has been since the FED began raising rates. That contraction has come mostly from the increase in treasury yields. I am using a 2-Year Treasury where you would usually see the use of a 10-Year Treasury Bond for comparison. However, the 2-Year is much more conservative, especially when my audience is primarily you all. Just from experience (mine and Kendall’s), most individuals will usually only go out to about a 2-Year maturity when they buy CDs at the bank.
Still, the premium offered by stocks today is 33% higher than the 2-Year Treasury. However, this is not such a wide amount that we feel we need to aggressively buy every stock on the shelf. Our overall equity balance is currently down due to the overall market declines last year, and because we took some profits. As I say in every letter, I am looking for bargains. You might assume that due to the market being down so much last year, bargains would be falling into our shopping carts, but so much of that decline was revaluing based on lowering earnings and predicted earnings of companies. That just means that I believe it continues to pay to remain cautious. We need to be brave enough to continue to hold a good portion of equities in our portfolios, brave enough to continue to buy good companies cheaply for future growth, and cautious enough to continue to wait for bargains of the best quality.
While we wait, we continue to earn more on our “safe money.” Our most recent fixed income purchase was a 12-week T-bill paying an annual rate of 4.7%. The average current dividend rate of our equity positions is 2.3%.
So, I will stop talking numbers now and instead get back to that “general” forecasting I promised… but I will leave 2022 market returns at the end of this letter for those who are interested, or for those who want to compare their own returns for the year versus the rest of the world. Although we had a tough year like everyone else, we did well in comparison.
General Forecast – I admit I am just as perplexed by the world today as everyone else. I speak regularly with many of you throughout the year. Many of you are retired, and many of you are still working. I talk to other people scattered across the business community. I watch the headline news, local news, financial news, fake news, and occasionally I get to watch some happy news… and all I can say is that if you talk to someone who really believes they know what’s going on in the world, and says they can predict what will happen next, chances are they may not be trustworthy.
Times are strange today, in both a social sense and rational sense. The quote I started this letter with came from a presentation given by First Trust’s chief economist, Brian Wesbury, at a recent conference call they hosted. He said it is currently impossible to use any kind of model to make forecasts due to the recent data that includes the government shutting the whole economy down, and then pumping it full of stimulus. There are no norms or even rules of thumb we can employ. So, we are only left with intuition, feeling, and common sense.
I believe, even if we find ourselves continuing to numb to things, that reality is not as horrible as we think. Inflation has probably already peaked and will continue to decline. A recession, especially at the global level, will probably occur. Countries are going to keep fighting each other, including militarily, and some of their newer policies will be more isolationist.
But… everything does not shut down because of any of this. I believe there is one thing we fail to talk a lot about with each other, both personally and at a larger social scale especially. It has taken a lot of cooperation to keep the world from burning these past three years. Cooperation and sacrifice were the true glue that kept everything together. It doesn’t matter what we’ve seen or believe to be our truths. It doesn’t matter how many fights we’ve witnessed, and how many mistakes and blunders of epic proportions were made. We got through it all because at the end of the day this is what people do. We work together to fix problems so life will be both bearable and better, and we complain and blame everyone else while we do it… but progress and enhancement are our average behavior, and will continue to be going forward.
The future is set to be better than it’s been. Businesses will cut costs and make smart investment decisions in the near term, which will lead to continued growth going forward. Businesses will also continue to work closely together with both partners and competition, because it is the only way they will be able to increase profits, which everyone wants to do. And this will all be reflected at the investment level. Things will probably get a little cheaper, but sometime this year the inflation rate will meet the borrowing rate, the scales will equalize, and those who participate will be rewarded.
I know some of you couldn’t care less about all the numbers, but some of you enjoy them. For those who do, I’ll just mention that Davos is currently in session, the big annual shindig where all the biggest (and richest as the media likes to bite their thumb at) leaders around the world get together and try to fix the world’s biggest problems. It is hosted by the World Economic Forum, which has an interesting history and from the beginning has truthfully seemed to want to make the world a better place through communication and entrepreneurial spirit. Anyway, their website offers a lot of numbers across a huge assortment of subjects, from global economies to the metaverse, to artificial intelligence, to the workplace.
As promised, I leave you with the 2022 yearly returns for some of the various markets I track. I hope you are heartened as you compare your own returns and can see by our own definition the conservative nature of our investing. I urge each of you to call or come in to discuss any fears, or changing goals, you may have. Our doors are always open.
Happy New Year,
Market Year-to-date Returns
The following are a group of index returns I update daily to see how various markets are performing. Not all investments are the same and not all stocks are the same, and I need to stay updated on how we are doing relative to the world. These are all year-to-date as of December 31st, 2022. This gives you the opportunity to compare your portfolio to many of the various broad options available to investors.
Kendall J. Anderson, CFA, Founder
Justin T. Anderson, President