WHAT THE 4TH QUARTER TOOK, THE 1ST QUARTER RETURNED
The market value that evaporated with declining stock prices during the last three months of 2018 reappeared in the first quarter. A contributor to year-end volatility was a lack of market liquidity, defined as the inability to buy and sell positions without impacting price. As panic selling subsided with fading concerns regarding future Fed rate hikes and continued stable economic conditions, confidence returned. The result was that much of what was ‘lost’ during Q4, returned during the first quarter.
We were comfortable with overall 2018 annual earnings. More importantly, economic conditions as we see them remain constructive. We continue to perceive a ‘Goldilocks’-like condition that is neither too hot nor too cold. Politicians and pundits may gripe that the economy should provide better growth, however, with near record low unemployment and little wage inflation, these two data points help explain sentiment. It would be great if workers could earn more, but at least everyone can have a job who wants one. According to the US Bureau of Labor, there were 7.6 million job openings at the end of January.
When it comes to investing, there are no bad assets, only bad prices. To be clear, there are opportunities that have poor return profiles at any price, but the amount one pays to acquire an investment plays an integral role in determining future financial success. For example, the technology giant Cisco Systems is a leader in providing equipment and services for our information technology world. Over the last five years the company’s shares have returned nearly 23% annualized, which is more than twice that of the S&P 500 Index. In cash terms, this turned $1.00 into $2.77 as compared to $1.68 for the index. Unfortunately, long-term investors who purchased shares at the top of the internet craze in 2000 don’t have a lot to show for their patience. Over the last 19 years, $1.00 invested is only worth 89 cents today. A similar investment in the market index would have returned 5.50% or $2.77.
Absolute returns are important, but so are relative returns, especially among various asset classes. In broad terms, we divide the world into three categories: equity (the owner and benefactor of residual value once all creditors are satisfied), credit (a claim on someone else’s assets or property) and hard assets (property, commodities, etc.). Comparing assets to one another is not an easy or straight-forward endeavor. Is an investment in an apartment building as attractive as an investment in an electric utility? It all depends on the assumptions one uses about the future.
Today, we have an intriguing dilemma. The macro assumptions used to support stock market valuations do not align with those used to explain interest rates in the bond market. The bond market, which is many times larger in size than the equity market, is pricing in a greater chance of a recession later this year or 2020. Four months ago, markets were concerned that the Fed would raise interest rates three more times in 2019 to stem inflation and cool the economy. Today, expectations are leaning toward a rate cut at the end of the year to help avoid a slowdown, if not a recession. On the other hand, stocks are pricing in more growth and expanding earnings. How do revenue and profits grow in aggregate when the overall economy (which is an indirect measurement of revenue and profits) is slowing or
We have commented in the past that both scenarios fundamentally conflict and cannot coexist simultaneously and, most assets, whether stocks, bonds or real estate, appear “expensive” when compared to historical averages. That could be concerning since it would indicate lower returns moving forward.
However, an important variable in the equation is changing and this affects the relevance of historical relationships. The percentage of wealth that is controlled at the top is rapidly increasing. More billionaires are created every year. At the top, those who control this wealth cannot possibly consume resources in the same way as if this wealth were spread out over the broader population. There are only so many dinners out, clothes, cars and vacations (items that drive economic statistics) one can buy, so it seems logical that a greater amount of capital is chasing a limited supply of investments, forcing prices higher. This helps explain why the price of a Picasso has risen significantly faster than reported inflation.As long as interest rates remain low (and there is no political will to allow them to float higher), we should expect real estate and other financial assets to trade at ever higher valuations, all things being equal.
With this framing, we are becoming more encouraged regarding the possibilities for greater returns from riskier assets. We are not throwing caution to the wind, rather just a bit more comfortable with higher valuations. We believe the United States will continue to lead economically, with the rest of the world following, producing more wealth for all.
We look forward to connecting with you and continuing the conversation.
-The EPIQ Team is Growing!
We are thrilled to announce that Mollie Grey has joined the EPIQ team as Manager of Partnerships and Events. She has
hit the ground running and is off to a fantastic start:
- EPIQ in the Community
Our very own Ben Frey is now the President of the Uptown Association, the neighborhood organization behind the annual
Uptown Art Fair, Minnesota’s second largest annual event by attendance:
- Save the Date: EPIQ Clambake - Thursday, September 26th
With guest speakers Gene Munster of LOUP Ventures and Jim Robillard of Spyglass Capital Management: