Wednesday, June 9, 2021

“Far More Money Has Been Lost By Investors Preparing For Corrections, Or Trying To Anticipate Corrections, Than Has Been Lost In Corrections Themselves.” – Peter Lynch

Probably a great deal of the investing public has never heard of Peter Lynch.  During my formative years of investing, he was the most famous investor of all time.  Peter Lynch ran the Fidelity Magellan Fund for 13 years with an average gain of 29.2% and had unparalleled success.  Even in the stock market crash of 1987, Fidelity Magellan Fund had a positive return.  I think his advice above is very important today as we face a recovering economy and an earning explosion.  

I became curious as to why so many investors are unwilling to invest more money during this time, so I did an informal survey to find out exactly what is bothering people and preventing them from investing.  I got many responses, but most of them centered around the potential increase of inflation, the wild and crazy spending in Washington whether the economy is actually recovering, a potential increase in interest rates by the Federal Reserve, and a basic misunderstanding of corporate earnings.  

Ava posing with her 10th birthday 
celebration signs

I have decided to address these issues, so my readers understand exactly where I stand.  I also want to give you information regarding the recovery of the economy that is in controversy.  It is so absolutely crystal clear to me that the economy is exploding on the upside, that it is fascinating to me that so many people continue to question it.  Also, I want to discuss general investing policy and how that affects your potential retirement.  I always like to quote the famous investor Warren Buffett, when he said “Do not save what is left after spending, spend what is left after saving.”  I intend to cover all those subjects and hopefully convince investors that many of the fears expressed above are either temporary or completely misplaced.  

Before I do so, I need to reflect on the performance of the financial markets for the month of May.  As you know the year 2020 was an extraordinary year on the upside for the markets.  It has also continued into 2021 with the markets continuing to rise.  One of the oldest sayings on Wall Street is, “Sell in May and go away.”  I think if you follow that advice over the summer months, you may miss a good opportunity.  

The Standard & Poor’s Index of 500 stocks was up 0.7% in the month of May and is up 12.6% for the year 2021.  The one-year performance on this index is an extraordinarily high 40.3%.  The NASDAQ Composite was down for the month of May 1.5% and is up 7% for the year 2021.  The one-year performance on this index is a 45.9% increase.  The Dow Jones Industrial average was up 2.2% during the month of May and is up 13.8% for the year 2021.  The one-year performance for the Dow Industrial is also an outstanding 38.6%.  Just for the sake of comparison, the Bloomberg Barclays Aggregate Bond index was up 0.2% in May, but is down 2.5% in the year 2021 and is also down for the one-year performance at negative 0.7%.  

Kari and Adam’s engagement 
photoshoot before their June wedding

If you compare the three major market indexes, which were up 38% or higher over the last year, you can see that the bond index was a major disappointment, reflecting a negative return for the one-year period ended May 31, 2021.  One of the major reasons for concern for investors is that they believe that inflation will soon impact virtually every item we purchase and every commodity that is essential for the everyday budget.  There is no substantial evidence that inflation will impact the economy this quickly.  In fact, if you go back and review the history of inflation, you will realize that it takes many years to actually affect the economy in general.  

I was here in Atlanta during the 1973 oil crisis.  Most people do not even remember that the reason that crisis occurred was because OPEC, “Organization of the Petroleum Exporting Companies,” decided to withhold oil from all the countries that supported Israel during the Yom Kippur War.  Basically, the OPEC countries decided that they would not sell oil to the United States during this time period and correspondently, the U.S. suffered through a substantial decline in its oil imports and a substantial increase in price.  During that time, the use of oil affected so many different aspects of the American way of life it forced prices up almost immediately.  The price of oil went up almost 300% from $3/barrel in the U.S. to nearly $12/barrel.
I can vividly remember standing in line to purchase gasoline during that very difficult time.  I also recall the dramatic increase in the price of a gallon of regular gasoline which rose 43% from 28.5 cents a gallon in May 1973 to 55.1 cents in June 1974.  Just looking at the above numbers you would think that inflation would impact the United States almost overnight.  But history reflects something else.  

It wasn’t until the late 1970’s (6 years later) that inflation really became a serious financial issue for the American economy.  Yes, we had inflation prior to that time and went through ill-placed actions by the government to hold down prices, which was unsuccessful.  However, it really got out of control during President Jimmy Carter’s years, when double digit inflation was commonplace.  The point of this scenario is that it takes years to impact the economy with significant inflation.  I think we are seeing that reflected today.  Even though prices are moving up, inflation in the economy is almost assuredly an event that will be years from now before it will affect and hurt the U.S. economy.  It even looks like some of the prices have already started to moderate.  

You also see it in the words of the Federal Reserve members that are most influential in controlling interest rates.  The most important regional bank in the Federal Reserve is the New York Federal Reserve.  Its President, John Williams, recently said we are “Still quite a ways off from maintaining substantial further progress.”  Basically, what he quoted was a reflection of Federal Reserve’s Jerome Powell’s many statements saying that the economy has yet to overheat and, therefore, any changes by the Federal Reserve at the current time would be unwarranted.  

There is also a clear misunderstanding of how inflation impacts financial markets.  There is no question that if the Federal Reserve started to increase interest rates dramatically, it would start to hurt stocks.  But using the Federal Reserve’s own words, that may be years away.  It is, however, already dramatically hurting the performance of bonds.  As noted above, bonds for the one-year period had a negative rate of return.  Bonds are not a good investment right now.  However, the effect on stocks is much more positive.  

Morgan seeing the waterfall while 
hiking at Roswell Mill

If you envision a company that has inventory and inflation had increased the prices of that inventory, they have instant gain with an increase in the underlying products that they sell to the public.  This instant increase in prices generates future higher profits for the company.  In addition, the assets owned by the company are likewise increased in value due to inflation.  Therefore, the machinery, equipment and real estate also have a higher valuation prior to the increase in inflation.  While these increases in valuation do not necessarily increase the value of the stocks, they dramatically increase the cost for a competitor to come in and compete with the company itself.  This increase in fair market value of the underlying assets is very much a positive for corporate earnings.  Why some question that runaway inflation would have a dramatic negative effect on the economy, it appears at the current time that this economy is literally “on fire” with the Federal Reserve waiting for future increases for future information to make any change in interest rates.  

There was a short-term sell off of the stock market last week when the Federal Reserve announced that they would be selling some of their corporate bonds that they have accumulated during the crisis.  However, what they did not specifically mention was that they would not be selling any of their Treasury bonds.  In fact, the Federal Reserve currently continues to buy Treasury bonds on a regular and continuous basis.  Most people are confused why the 10-year treasury has not moved significantly above the 1.6% rate when reported inflation is well above 2%.  There is a specific reason why that rate is continuing to be steady.  With the Federal Reserve basically buying up all the excess Treasury bond issued it is unlikely that rate will move dramatically without the Federal Reserve backing off.  At the current time, the Federal Reserve announced that it is not their intention to back off on these purchases prior to 2023.  Therefore, if your major concern is that inflation would impact the value of your stocks on a current basis, that is misplaced.  

Danielle, Reid and Caroline smiling for this 
sweet shot

One of the items that always perplexed me was why people do not save more.  I get the answer as quoted above by Warren Buffett that they just don’t have any money left over after their monthly expenditures to save.  What I have seen over my 50 years in the business, young couples come out of college and both begin working simultaneously and make a good income.  Over time they just increase their expenses so that their monthly budgeting equals basically their income.  When asked why they do not save more they reflect upon all the expenses and indicate there is nothing left to save.  

I often question why people tell me they only put in their 401(k) plan exactly what the company matches.  Since a 401(k) is, under current tax law, the absolute largest tax deduction a young professional could get, you wonder why they do not participate more.  In fact, in most cases, virtually all workers should attempt to maximize their 401(k)’s on a regular basis.  If you look at a chart where you start to save early in life and continue to save over time, a financially secure retirement is almost guaranteed.  However, if you wait until later in life the difficulty to accumulate these amounts are enormous.  

As we all know the stock market on average goes up 9% a year,  yet too many people are trying to time the market and ignore that proven fact.  If you look back to March 2020 all the people that sold out of the market during that time period were the losers in a financial market that was legendarily high.  Take a look today at all of the cash sitting in checking accounts.  It is now estimated that over $3 trillion is sitting uninvested in money market accounts today.  We all know that money markets are paying virtually zero interest and CD’s are paying almost zero.  As noted above, over the last one-year period, the S&P 500 is up 40% and money market accounts are up 0.1 of 1%.  You do not have to be a Philadelphia lawyer to understand the value of being invested as compared to being in cash.  

The Schultz family in their
Sunday Best

Last week the Commerce Department reported that May hiring increased by 559,000 employees.  It also announced that the unemployment report dropped from 6.1% to 5.8%.  However, with those numbers came out the stark reality that there are still 9.3 million people in the United States that are unemployed and potentially available to work during the month of May.  One of the major components of inflation is job-related wage increase.  It should be evident to everyone that hiring is almost at a standstill in America because so many workers refuse to go back to work.  There is no shortage in employees, there is just a shortage of people wanting to work.  Virtually all industries that pay minimum salaries are searching for employees to fill those positions.  One of the major reasons quoted is that the extra $300 a week in Federal unemployment insurance is causing employees not to want to work, and to stay home and collect benefits.  It has already been announced that 25 states will eliminate this $300 increase, effective immediately.  The President also announced that these increases will stop immediately in September of 2021.  The economic effect of stopping these increases in Federal unemployment should be obvious.  If only half of the people currently unemployed now take jobs, since unemployment is unprofitable, the economy should pick up even further.  These are people paying taxes and consuming once again to help the economy grow.  

People ask me all the time how I knew and how I was correct regarding the absolute turn around in the economy during the early parts of 2021.  Basically, I look at the numbers every day to determine whether the economy is moving ahead or sideways.  But if you want to hear information that is more down to earth and easily understood, look at the case of Las Vegas, Nevada.  For the month of April their weekend occupancy in their hotels was 83.5%.  In January, that weekend occupancy was 48%.  During the month of April there were 2.9 million air passengers coming into Las Vegas.  In the month of January there was 1.5 million.  Most importantly, during the month of April the unemployment in Nevada was 8%.  During April of 2020, the unemployment in Nevada was 29.5%.  As you can see there is a real-world increase in the economy happening overnight.  

I happened to fly to Florida over the Memorial Day weekend and can report that the airports were completely crazy on Memorial Day.  There were lines to get into restaurants lined up down half the corridors with passengers.  There was a shortage of rental cars in both markets and the airport appeared to be exactly at the same level of capacity that it was prior to the pandemic.  I flew quite a bit during the pandemic and can report walking into Tampa International Airport at seven o’clock at night and there not being one single passenger other than me.  This most recent trip, the airport was virtually at capacity of people trying to catch flights out of Tampa.  

DeNay visiting the incredible
 Van Gogh exhibit

Another common reason I hear people will not invest in the market is that the market is too expensive.  One of the things I that I try to do with potential investors is ask them how they have determined that the market is too expensive.  Well basically they read what is quoted in major publications and believe those facts and figures to be accurate.  But one of the things misunderstood by the investing public is that if the price of stocks are at a certain level today, but earnings continue to go up, doesn’t that mean that prices will be cheaper in the future?  As I have often said in these postings, the most important component in pricing stocks is the level of earnings of these stocks.  At the current time, earnings are exploding to the upside and the public does not seem to get the point.  It is now being forecast that earnings from the period from May through December of 2021 will increase a dramatic 23% higher from where they were in May.  If earnings continue to increase, as I suspect they will, stocks will continue to get cheaper.  Why would you not participate in this increase when we absolutely know it is occurring all around us?  

One of the major concerns of the investing public has been the pandemic and the spread of COVID.  Maybe you haven’t noticed that COVID infections are down close to 90% of what they were six months ago.  In the entire Unites States yesterday there were only 11,000 new cases.  Deaths from COVID are falling dramatically and now average around 400 a day as compared to several thousand six months ago.  If we could encourage the rest of Americans to get vaccinations, heard immunity could be reached this summer.  Already 63% of Americans over the age of 16 have now been vaccinated at least one time and the number of vaccinations is going up roughly at one to two million a day.  It is very clear that the vaccinations are stymieing the spread of this terrible virus.  Correspondingly, as cases go down the public is out again spending all their accumulated resources.  Given the fact that they have not been able to spend over the last 14 months, you are seeing an explosion in hotels, rental cars and virtually any type of lodging on the beach.  

This upward explosion of the economy has occurred without the new Federal money that is being discussed to spend in Washington.  At the current time, Congress is considering an additional $4 trillion of Federal stimulus in the way of infrastructure type changes.  This would provide funds for additional roads, highways, bridges, dams, etc.  While all those things are clearly needed, dumping all that money into an already overheated economy will only make the shortage of commodities worse over the short term.  It is my opinion that Congress will go slow with these increases, and we will not see them implemented until much later in the year 2021.  

Jodi Dufresne, 36-year client, enjoying
 her horse on a spring day

So where do we really stand on the economy and exactly what does the future hold? While no one can truly predict the future, we do have some evidence of exactly where we stand.  The Federal Reserve of Atlanta makes a projection of future GDP growth based on their internal models.  Currently they are forecasting an increase of GDP for the second quarter at 10.3%.  The entire Federal Reserve is forecasting the economy in the U.S. for the entire year of 2021 to increase above 7%.  If we were to end the year with a 7% increase in the economy that would be the best yearly increase since the Ronald Reagan years.  There is no question that the economy is coming back in a big way.  We all see it every day around us and just like I predicted, the increase will be substantial and long-term.  

In circling back to the original reason for writing this blog, I am questioning why people will not invest all the cash they are sitting on.  After a dramatically higher year in 2020 and a great start to 2021, everyone should consider investing their cash that is earning nothing for long-term results.  We now know that the three components of higher stock prices are firmly in place.  The three components of higher stock prices are interest rates, the economy and corporate earnings.  The chairman of the Federal Reserve, Jerome Powell, has confirmed that he has no intention of restricting the economy or increasing interest rates prior to 2023, which is a cool 18 months from today.  We know based upon the information presented above that the economy is totally on fire.  Businesses today are dealing with the exact opposite that they dealt with over a year ago.  Corporate America is trying to hire employees, but they cannot do so.  Everywhere you look, employers are seeking employees but cannot fill those positions.  

Josef Martinez, Morgan and Kari 
catching a Braves game

These trends are a clear indication of the strength of American corporations since they are now hiring rather than laying off employees.  Also, we know that corporate earnings are dramatically increasing and even the pros are forecasting an increase in earnings in 2021 of greater than 20%.  There are many forecasters that think in the last half of 2021, corporate earnings will be even higher.  It is a fairly conservative forecast that the earnings will be higher given all of the new employees that have gone on the payroll in the early 2021.  In addition to the prior Federal stimulus, if the government continues to give out free money to Americans and businesses, we expect the economy to grow even faster and bigger.

So, my forecast for the future looks like an economy that will continue to grow, earnings that will continue to increase and interest rates that will be stable.  That is the trifecta of positive economic data that will lead to higher stock prices.  There is absolutely no question that the concern of the Federal deficits will increase inflation.  However, my assumption is based on history that the increase in inflation is years away rather than months away.  We also know that eventually the Federal Reserve will have to increase interest rates to slow down an overstimulated economy.  Once again maybe years from now, but not months from now.  As we go forward to the summer and more and more Americans become vaccinated and corporate travel and recreational travel doubles, you will see corporate profits unprecedented in modern times.  All these positive economic effects will have a negative effect on bonds, but a positive effect on stocks.  

There has been a dramatic change in the investing of growth stocks in the last part of 2020 and the first five months of 2021 as there has been a transfer to value stocks due to the turnaround in the economy from recession to expansion.  However, do not give up on the growth segments of investing.  The growth companies such as the large tech companies are recording profits unprecedented in American commerce.  All of the positive economic events represented above will only increase those profits, not decrease them.  While values stocks are certainly rallying in the first part of 2021, I see a shift back to growth this summer and an expansion of growth for the rest of the year.

As always, the above comments are based on my personal research and my personal opinion and certainly no one can forecast the future accurately.  However, the realization that the economy has already turned should be self-evident and those who are sitting on cash should be moved to make appropriate investments. 

On that note, come visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins