01 Oct Busy News Cycle: We Look Forward – 2024 Q4 Commentary

There is one mantra that Morris & Wells clients and prospective clients hear all the time from us – probably to the point that your eyes glaze over – “Volatility is opportunity.” We live that phrase. We think the second mantra on our list is, “There is always something to worry about.” We take the latter view because the financial media and media in general have to have something to talk about and worry typically generates the most clicks and ad dollars. There are times though that the volume of things to worry about seems higher or lower than usual. Today it feels to us like the media and investors have a higher than normal number of worries. As we write this we sit five weeks away from the US Presidential election. The Federal Reserve lowered the federal funds rate for the first time in a number of years in an attempt to accomplish a “soft landing.” The after effects of embedded price increases following rampant inflation make goods and services more expensive for consumers. The US economy might be slowing. The S&P 500 seems highly valued. China’s economy is slowing, and you can likely name many more concerns. How can we navigate through all these issues?

The number one answer to the question above is that if you, your family, or your organization need cash, let us have a conversation and make sure that the more conservative portion of your portfolio is aligned with your needs. Please let us know if this describes you. We will attempt to tackle the rest of the worries in this newsletter.

First, the US Presidential election presents two candidates whose policies and would-be policies are familiar to the market. Potential policies differ for each candidate but we still think the market volatility will precede the election and not follow it because of the market’s familiarity with each candidate. We own companies within the portfolio that could see an increase in share price with a victory from either candidate – those companies are not necessarily the same.

The Federal Reserve recently lowered its Federal Funds target rate to 4.75% to 5.00%. One of the main drivers of increased rates over the last couple of years has been the Fed’s attempt to fight inflation – interest rates and inflation move inversely in theory. Graph 1, below, illustrates some of the categories of goods which have seen inflation over the last four years. As you can see, a number of the categories are not discretionary. Americans have pinched budgets from rising gasoline, insurance, energy, electricity, and food costs. Graph 2, below, highlights the extreme jump in car insurance premiums since the pandemic. The Fed increases rates to cool off the economy and in theory cease the inflation seen in goods and services prices, like car insurance. So, the Fed has begun to decrease rates because it sees inflation coming down (currently 2.5% to 3.5% per year) and it does not want to choke the economy with high interest rates. However, that does not mean that prices will necessarily come down, just that the rate of price increases is not going up as rapidly. The Fed seems to be walking a fine line trying to influence inflation lower while not letting the economy fall into recession. For us as investors, the key is that the economy does not fall into recession. If the US avoids that, we think the Fed may pull off its “soft landing” of lessening inflation and strong employment.

A slowing US economy does not mean one that will fall into recession or cause wide spread pressure on corporate earnings. At the moment the US consumer continues to spend and remains employed. Graph 3, below, shows a level of jobs listings on the same level as prior to the pandemic. Similarly, Graph 4, below, illustrates growth in weekly same store retail sales. Also, Americans continue to spend on eating out. Graph 5, below, shows the seven day moving average percentage change in restaurant bookings. That figure appears stable and suggests a lack of consumer economizing in that area. All of these points suggest, at least for now, the US consumer continues to work and spend money, which we view as the key to combating the above worries about the US economy and keeping economic growth on track. With the US consumer in good shape, we want to make sure corporations appear in good shape too.

Graph 6, below, illustrates that corporate profits margins have never been higher. This suggests a few things. First, S&P 500 companies, especially the larger market capitalization technology companies, have been able to significantly increase their margins and keep them high. Second, perhaps some of the price increases connected with the previously mentioned inflation have stuck and dropped down to companies’ net income. Third, Wall Street as a whole has been skeptical about the sustainability of this type of margin profile. Morris & Wells has been vocal that it seems as though some degree of margin improvement and strength seems embedded. In other words, companies have successfully adapted business models and we may be in a structurally different margin environment than the early 2000’s.

If accurate and S&P 500 company profit margins find themselves structurally higher, then the S&P 500 index deserves a higher multiple of earnings (Price-to-Earnings) ratio than the past. How much higher, we do not know. The S&P 500 earnings multiple (valuation) does look stretched today. However, as we have discussed before, many companies within the S&P 500 and other companies look reasonably valued. So, valuations in and of themselves do not constitute a major concern for us today.

Finally, from the list of worries above, the Chinese economy does show signs of slowing growth. This affects the global economy and certainly price setting for several commodities because China ranks as a large marginal consumer of many of those commodities – such as copper and oil. As we write this letter, the Chinese government has instituted a stimulus package. That support comes in the form of monetary stimulus (lowering interest rates) as well as fiscal stimulus (in this case, getting money directly to financial institutions to purchase stocks). We have seen the market’s interpretation of that stimulus in rising copper prices and rising Chinese stock prices. We will not know for a while whether these attempts at stimulus will revive Chinese economic growth. However, we view the stimulus as a positive because it says the Chinese government recognizes the issue and wants to support its economy, which in turns bolsters the global economy.

We began this newsletter with a list of stock market and economic worries that seem greater in number than usual. We hope that we have addressed these concerns. We think a lot of these worries have been reflected in stock prices, maybe too much. That provides opportunity as we do think a number of companies look like great values as a result. If you share any of these concerns or have others, we want to discuss those with you. Please reach out to us via phone, email, ask us to setup a Zoom, or knock on the door. For those who could attend our client event at The Boar’s Head Resort or via Zoom, thank you. It was great to see so many of you and share the interesting cybersecurity and banking content from Schwab. We look forward to hosting you again in the future and staying in touch as we navigate these uncertain times.