I am currently reading Daniel Defoe’s 1722 novel A Journal of the Plague Year. It is a fictionalized account of the bubonic plague outbreak in London which reached its peak in 1665. These days, it is a relatively obscure book, and can be a real struggle due to the early 18th Century language and what passed for punctuation at the time.
As to how I chose this particular book, let me respond with a question:
Have you ever surfed the Internet and found yourself, much later, on a website which had nothing to do with your initial search? It is sort of like that.
What I have found interesting is the realization that the more things change the more they stay the same.
Way back when, in order to combat the ‘distemper,’ they imposed quarantines on the sick. The authorities shut down businesses. The rich retreated to their estates out of the city. There were what we now call supply-chain disruptions. Paranoia was rampant. Religious zealots proclaimed the plague was God’s wrath and the end of days. A shortage of healthcare providers attempted to combat the sickness with untested ‘physicks,’ meaning medicines. The less ethical preyed on the fears of the masses to make a buck, or pound as the case may be.
The list of similarities with our recent unpleasantness with COVID-19 is eerie.
Apart from our response to viral diseases, 350-years apart, it seems history is repeating itself across the globe with increased frequency.
- The Russians fighting against Ukraine, and trying to increase their empire? Check.
- Israel struggling against its neighbors? This is a frequent story which goes all the way back to the Book of Genesis.
- China expanding its suzerainty throughout East Asia? History tells that tale a time or three.
- Haiti descending into chaos and economic ruin? Unfortunately, that seems to be a constant.
- Politicians pandering to their base? Yep.
- Stock prices surging without any good reason, almost in spite of themselves? Oh, am I really going there?
Don’t get me wrong. I am not preaching doom and gloom. Far from it. Over the long haul, equities (ownership) are a powerful wealth generator, the best even. Despite Washington’s best efforts, tongue in cheek, the United States has the most dynamic, entrepreneurial and liquid major economy in the world. To that end, I would rather own U.S. stocks than any other primary paper asset class over the long-term.
That doesn’t mean they are always a good deal.
Consider the following analogy. Imagine there is a nice house in a nice neighborhood where the median price for homes is, say, $1 million. The number is irrelevant. It has all of the desired bedrooms, bathrooms and accruements, and isn’t in need of any structural work. You can think of it as the very definition of the median home.
Now, imagine the owner puts it on the market for $750K. All other things being equal, is that a good deal? Would a potential homebuyer be wise to gobble it up?
What if they listed the same house for $1 million, the median price AND it is the median house? How about $1.25 million or even $1.5 million? Remember, there is nothing wrong it, and should continue to appreciate over time. But, is it a good deal for the buyer at, say, $1.25 million? Or is it a better deal for the seller at that price?
As you know, thus far through March 21st of 2024, the S&P 500 has continued its feverish pace from the end of 2023. To be sure, a fistful of individual names and fewer economic sectors have fueled the rally. But do index fund investors really care? Money is money, and general market investors simply have more of it.
The reason? Well, it probably isn’t recent earnings results or expectations. After all, the price/earnings ratio (P/E) has mushroomed through the first three months. This basically means investors are willing to buy more for each dollar of profit. To that end, according to my handy Bloomberg terminal, the market’s accepted P/E before extraordinary items has jumped to almost 25.5 as I type here on the 22nd of March. It was about 23.5 at the end of 2023 and, get this, around 19.0 on December 31, 2022. That is impressive multiple expansion, as we call it in the investment industry.
Make no bones about it. Investors are willing to buy more for each dollar of profit, I would argue a lot more, than they were before. Going back to our little analogy, it would seem the home, which was selling for $750K at the end of 2022, is now listed at $1.25 million.
Of course, you could argue the reason for this is the prospect for Fed rate cuts. These will reduce the cost of money in the economy, stimulate economic growth and potentially boost corporate profitability. As such, those P/E multiples are reflecting the existing cost of money NOT what it will be moving forward. So, why wouldn’t investors want to buy now in anticipation of better times ahead?
No argument. Over my 33 years in the investment industry, I have been there, done that and believe that last paragraph to be essentially true. However, that sort of multiple expansion, from 19 to 25.5 in anticipation of a potential 0.75% reduction in the overnight rate at some point this year? Hey, there are always limits, and stocks don’t just keep going up like the glass elevator at Willy Wonka’s factory.
Just like Charlie and the Chocolate Factory, I have seen this show a few times. So, hold on Charlie Bucket. You had better grab Grandpa Joe’s hand.
That isn’t to say we are standing at the precipice like we were in 2022 or 2008. We aren’t. However, at best, stocks won’t keep going up the way they were. At worst, they could have a pullback like they did during the 4th Quarter of 2018. In all probability, the truth will be somewhere in the middle. Some red ink spread over a few months, but not a bloodbath.
With this in mind, for the first time in 2-years or more, our Investment Committee raised cash in our primary investment strategies this week. That is to say we sold stocks. This move will take us from a pretty significant overweight in equities to a more marginal one.
Again, we prefer stocks long-term. We aren’t worried about economic or financial Armageddon at this time. We simply think the domestic stock market is reasonably, if not fully, valued and there is now more downside risk than there was.
As for what we did with the proceeds, you will have to call your Oakworth client advisor or investment officer to find out. If you don’t have one, we would love to talk with you about correcting that affliction. For unlike the bubonic plague in London in 1665 there IS a cure for that.
Have a great weekend.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this any every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.