It’s been a whirlwind stock market since early October with stocks at their lows for the year heading into this holiday season. All three major stock indices, the Dow, NASDAQ and broader S&P 500 are deep into correction territory this year. The Russell 2000 which tracks U.S. small cap stocks is officially in a bear market, or down over 20%. While a “Santa Claus” rally is certainly possible, it’s looking increasingly likely that the U.S. stock markets will put in their worst year since 2008.
The bond market, which normally offsets stock losses by rising when stocks fall, is also down this year. It’s quite rare for both stocks and bonds to be down in the same year and making fresh lows at the same time, which limits the value of broad diversification.
No matter how you slice it, it’s been a tough year for investors in just about any asset class.
The narrative currently driving stocks down is that global growth is stalling out and that the Fed is going to keep raising interest rates and tightening financial conditions. That’s the bad news. Just 12 short months ago the narrative driving stocks to fresh all-time highs was that the world was experiencing synchronized global growth. This goes to show just how quickly market perceptions can change, both for better and for worse.
Here’s the good news: markets are currently pricing in a global recession in the next 12 months and any outcome that’s even slightly positive should produce meaningful upside in stocks. Furthermore, some of our favorite long term investments are available at what will sooner or later (likely sooner) be considered bargain prices.
In fact, given the current pessimism rampant in markets and dramatically lower valuations, we think this is the best environment to make long term investments we’ve seen since 2012. For the last few years, it has been difficult to find good companies with growing profits trading at less than 25x earnings. Today that script has been flipped and we’re finding wonderful businesses with bright futures that are gushing cash flow trading at 15x earnings or less. Historically speaking, buying good companies at average prices when sentiment is negative has been a recipe for success. This is what we’re finding today.
Whether the selling abates tomorrow, next week or next month is impossible to say. What is definite is that at some point in the near future, after investors and speculators alike take a deep breath, people will be reminded of a few key points.
At current prices stocks are still a superior long term investment to cash, bonds and almost all forms of commodities and real estate.
Interest rates are still very low by historical standards and likely to remain extremely low for the foreseeable future…we have been believers that interest rates will be “lower for longer” for many years and that trend is likely to continue which boosts the long term value of assets like stocks. Whether or not the Fed raises interest rates this month, they are most likely done for a while. Once the dust has settled, investors will look at guaranteed returns on government bonds of 2.5% per annum and eventually conclude that the juice of higher returns in stocks is worth the squeeze.
Take the Walt Disney Company, for example. The House of Mouse, the premier entertainment business on planet Earth, is currently on sale at just 14x last year’s earnings. The last time Disney was this cheap was 2012. For context, Disney only briefly traded below 10x earnings in the depths of the financial crisis and traded for over 22x earnings just three years ago. Keep in mind that Disney will own all of 21stCentury Fox’s assets in a few months and will own the intellectual property of just about every major film franchise in the world with the exception of the Jurassic Park series. Next year will also mark the launch of Disney’s direct-to-consumer streaming app and future Netflix rival “Disney+”. For any parent with young children, the Disney+ streaming service, which will feature franchises like Marvel, Pixar, Star Wars and more (as well as all the Disney classics), will be must-have entertainment.
Or look at the largest cable providers like Comcast and Charter Communications. Together these two companies provide broadband internet service to over half of America and are effective monopolies in the communities they serve (just like our local cable monopoly Cox Communications). They’ve just completed a multi-year investment cycle which will enable them to deliver 1Gbps internet to everyone they serve. That speed enhancement means these internet services will be 3-10x faster than most other internet providers in the country at a time when household data consumption is exploding and growing at 20%+ annually. These companies face no legitimate threats, either competitive or technological, in the near future, meaning these companies’ earnings streams should be as consistent as they’ve been in recent years. Both companies grew revenues even through the financial crisis. Local monopolies with entrenched positions, superior technology and declining costs now that their big investment cycle is ending… all for 8x (Charter) and 7x (Comcast) this year’s earnings. Do you think of your internet service as a luxury or a necessity like a utility? Will you cancel internet service if the stock market falls 10%? If you answered ‘utility’ and ‘no’, we’ll do more than fine in our cable company investments.
What about the little shop around the corner selling food and wares at “Everyday Low Prices” known as Walmart? Is Walmart going to suffer if the stock market falls 10%? Doubtful. In fact, won’t MORE people shop there if they don’t feel so hot about their financial situation? Whether the stock goes up or not, Walmart has grown its VALUE every year like clockwork for decades on end. 2018 was the first time in the history of the world that a company sold $500b worth of goods and services… that was Walmart, more than the sales of both Warren Buffett’s Berkshire Hathaway and tech favorite Apple COMBINED. If Walmart wasn’t investing so heavily to grab market share in online retail (Walmart.com sales are growing at 40% per year, faster than Amazon.com), it would trade at an average market multiple of earnings.
While you may not own all the stocks discussed above, chances are you own some or most of them. And you certainly own many just like them. While the volatility of the past few weeks has been highly unpleasant, it is a normal function of stock markets. By sticking with our top-class investment holdings like those mentioned above, we give ourselves the best chance of meeting our financial goals over time.
Should markets continue to be volatile in the coming weeks and months, rest assured we will continue making adjustments to your asset allocation to maximize returns while minimizing risk as much as possible.
As always, should you have any questions or would like to speak to one of your advisors, just let us know and we’ll be happy to assist you.