The Divergence Continues

One of the big themes we have been discussing with clients this year is the divergence we have been seeing across asset classes.  In a world where globalization seems to tie things even more closely together, the opposite has been occurring in the investment markets.  Here are the numbers from The Capital Speculator:


Many of us in the US have been watching CNBC with the belief that the markets have been on an upward climb this year, which is only partially true.  The US stock market has been, but the rest of the world has fallen behind.  In addition, with rising interest rates, the normal safe haven of bonds has been compromised.  So what should investors do now?  Looking backward, those of us with diversified portfolios probably wish we had put everything in the US stock market at the beginning of the year.  Since we can’t go back in time, we still encourage investors to maintain diversification across multiple asset classes.  There will be a time in the not to distant future, that those who remain diversified will be thankful they didn’t have all of their money in US stocks.  When you adequately diversify your portfolio you may not outperform the top performing asset class, but you also won’t underperform the worst.  For the majority of investors, this is the best strategy when developing a portfolio.

Revisiting The State Of American Business

With 98.5% of the companies in the S&P 500 reporting their earnings for the second quarter, we thought it would be a good idea to revisit the state of American business and what the outlook is for the future. 


The lifeblood of any business sales.  Sales were up 2.4% from last quarter and 3.4% from last year.  We are seeing sales accelerate this quarter which is a far cry from what many commentators have been discussing.  Many are saying that companies are only earning more money because they are cutting costs.  While costs are being managed diligently, sales are growing and are up 17% over the past 3 years.


Earnings are one of the major drivers of stock market performance over time.  These earnings were up 2.3% from last quarter and 3.7% from last year.  As you can see, these match pretty closely with the sales growth numbers, meaning that companies are not only adding sales, but are also adding expenses.  This is also evidenced that profit margins (or the amount of earnings you generate for each dollar of sales) remained basically unchanged  at 9.5%.  With margins at such elevated levels (compared to history) it is hard to believe companies will be able to continue to grow their earnings from additional cost cutting.  Most earnings growth will need to come from continued expansion of the company’s sales.


Dividends are probably showing the most promise, with cash dividends up 8.3% over last quarter and 15.6% over last year.  With companies seeing only minor benefits from investing in their business, and historically low payout ratios (amount of dividends paid divided by profits) this is a promising sign.  The dividend rate is now at 2.15%, which is still a very attractive yield when compared to fixed income investments. 


Are stocks cheap or expensive?  The company’s price compared to its earnings are usually a good indicator to look at.  At the end of Q2, we saw the price-to-earnings ratio around 16, which is close to its long-term average over the past 25 years.  Compared to a year earlier, the P/E ratio has expanded from 13.8, meaning that stocks are still around their long-term average, but are more expensive than they were a year ago.  This should be of no surprise to those of you who follow the markets.  The S&P gained over 18% over the prior year while earnings grew at a much slower pace, pushing up valuations.

Looking forward

Analysts expect earnings to grow 2.7% next quarter and 14% in the next year.  These estimates have been coming down lately so it is hard to tell exactly where these will end up, but anything close to these estimates should be welcomed news for the markets.  One of the big question marks is not just earnings, but how the market will value those earnings.  If the market is willing to pay the current multiple or more for earnings, this next year could see continued gains.  If the market pays a lower multiple for those earnings, we could even see losses.  This is why predicting the future is so hard.  You not only have to know what a company will earn, but you also have to know how the market will view those earnings. 

For the time being, Greenspring continues to encourage investors to maintain balance in their portfolio, with a healthy weighting still allocated to US stocks.

Source:  Standard and Poors

Maturities Matter With Bonds

One of the biggest stories from the past few months is the spectacular rise in interest rates.  If you are going to be borrowing money over the coming weeks and months this is unwelcomed news.  You will most likely be paying higher rates to finance your debt.  But there is one group who should be excited about this rise in rates; those who will be saving over this time period.  As savers put money to work into money markets, CD’s and bonds, they will be seeing their investments accrue higher rates of interest.  But what about those investors who already have money in those investments?  If I invested a chunk of my money in bonds a few months ago, I am probably kicking myself right now, since I locked in an interest rate at a much lower yield than today’s rates. 

This is why bond values (especially long-term bonds) lose value when interest rates rise.  Vanguard ran a hypothetical analysis on two different bond portfolios and the impact a 3% increase in interest rates would have: 

As you can see, long-term bonds (green line) get hit much harder than intermediate term bonds (blue line) when rates rise, and the breakeven period can be extremely long.  For this reason, Greenspring has continued to keep our clients bond portfolios in short duration investments, minimizing the risk of rising interest rates.  While you will get smaller current yields, the shorter duration allows the bond portion of your portfolio accomplish its number one goal:  risk reduction.  



Same As It Ever Was

There is a phrase I hear often in our business that makes me cringe…”this is a stock pickers market”.  This phrase seems to emphasize that at this period in time there is some value in trying to select winners and losers in the stock market.  It is almost always uttered by stock pickers and it is funny that it uttered no matter what type of market it is.  If the market is going down stock pickers will argue that a good stock picker can avoid the big losers and focus on defensive stocks.  As the market climbs, they will be able to move money into cyclical stocks and avoid the boring ones that would weigh down returns.  If you’ve read our blog in the past you know that we are skeptical about these claims since there is no data to support it.

Investment News wrote an article citing Vanguard research on the topic:

Every year since 2008, more than half the stocks in the S&P 500 have finished the year with a return of 10 percentage points or more or less than the index, according to research by The Vanguard Group Inc.

That means there are at least 250 stocks in any given year that a portfolio manager could choose to overweight or underweight to boost returns versus the index.

This year has been no different. Through Aug. 19, 262 companies have returns that are more than 10 percentage points more or less than the S&P 500’s 15.4% gain, according to Lipper Inc.

This is pretty fascinating.  According to the research, stock pickers have about a 50% chance to be spectacularly right, or spectacularly wrong with every stock they select.  Unfortunately, all of the skill at analyzing stocks, fundamentals or technical patters doesn’t seem to give these managers an edge:

Even with the majority of stocks offering managers a way to outperform one way or another, 56% of the 287 large-cap-core mutual funds tracked by Lipper are trailing so far this year, which shouldn’t come as much of a surprise.

Could it be that outperformance is attributed more to luck than skill?  That managers really have very little ability to consistently outperform the market and/or their peers?  We believe that is the case, not because of some intuition or gut feeling, but because the data tells us so.

Are Low Paying Jobs The Only Ones Being Created During This Recovery?

One of the big reasons that people have downplayed this employment recovery is the narrative that almost all of the jobs being created are part-time or low wage jobs.  I was particularly interested to read this article from The Federal Reserve of Atlanta.  They reviewed recoveries from the past several decades to find out if this one was any different in relation to the types of jobs being created.  The chart below is from the article:


So, the argument we’ve heard from many that nearly 50% of the jobs being created are low paying is correct.  What is also correct is that this is completely normal, and has been about the average for recoveries since 1970.  This is why it is so dangerous to listen to political or economic commentators.  They often have an agenda.  Those talking about the weak jobs recovery may have a political axe to grind.  Or they may be a fund manager who is betting against the stock market and wants to influence people to sell stocks.  Taking a more balanced, data driven view is advisable whenever you are making decisions about your money.

Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.