It may seem harder to find good investment opportunities today, but it’s always difficult. There is a mounting belief that global economies are getting worse, not better. But the facts differ. The principal ongoing concerns include: Europe’s recovery prospects after Brexit, the effectiveness of ECB’s monetary easing program, the deflationary price trend for commodities, the slowdown in China and emerging markets, slow U.S. growth, geopolitical and terrorism risks, and, last, but not least, the outcome of the U.S. elections. The IMF’s outlook just released projects this year’s global growth rate at 3.1% and next year at 3.4%. While some of these concerns in the market might happen, we know from experience that more bad things could happen in the future than will actually happen.
There is a perception that the U.S. economy is growing at such a slow rate that it could stall and bring on a recession. But there are no signs that the U.S. is on the brink of secular stagnation, deflation or recession. The IMF projects U.S. growth at a reasonable rate of 2.2% for this year – slow growth to be sure, but it doesn’t portend a boom or a bust, and it’s at a rate that is sustainable over the future. Residential housing is expanding, personal consumption trends remain strong and corporate earnings are rebounding from the low reached in the fourth quarter of 2015. Employment growth continues to proceed at an average rate of 200,000 a month and the unemployment rate has been staying low at 5.0%.
The U.S. Federal Reserve and central banks in other developed countries have been so preoccupied with the potential risks in their economies that they have been aggressively pursuing monetary easing in an effort to stimulate growth. This has depressed global interest rates to historically low levels and in the Euro Zone, Japan and elsewhere to negative rates where investors pay countries to invest their funds. In the search for yield never have so many investors paid so much for so little return. While the Federal Reserve had been pursuing its zero interest policy for the last 8 years, it did take a first step toward normalizing interest rates by raising the Fed Funds rate by 25 basis points in December, 2015. Janet Yellen’s Federal Reserve is the most dovish ever and is likely to raise interest rates very, very slowly for the foreseeable future.
The U.S. stock market has risen steadily from the low in March 2009 to the present level which is close to an all-time high, for a gain of 220%. On balance we consider the valuation metrics to be reasonable. Earnings for the companies in the S&P 500 Index are continuing to grow and large-cap stocks that we favor are priced in line with their historical averages. The U.S. market is not a rosy scenario, but it is attractive relative to all other markets.
Risk control is a critical component in successful investing. Some say that volatility is a risk, but volatility is not really a risk for those with a long-term horizon; it is an inherent characteristic of markets where prices can move around a lot. Volatility (VIX) in the stock market is a measure of the variation in stock price movements relative to the S&P 500 Index over time. In the long run the market can be more logical so that the underlying value of a stock tends to be reflected in its price. But in the short-term when markets are influenced more by emotions than facts, stock prices change a lot more than their underlying values.
Volatility is the friend of long-term investors who have the discipline to buy attractive stocks when others are selling. Whitnell’s disciplined approach is to buy stocks when our intrinsic value approach identifies stocks of companies that are selling at prices less than we calculate that they are worth and hold them as long as their value continues to rise along with the stock price.
The key to successful investing is the preservation of capital. The way you do this is by not taking big risks. Investors need to understand that the risks that can result in a permanent impairment of capital are 1) Business risk – the basic fundamental operations inherent with the issue. 2) Financial risk – the dangers inherent in excessive leverage, and 3) Valuation risk – the risk of paying too high a price for an asset so that the return falls short of the return that is required for the investment to be profitable. Valuation risk is the biggest risk of all.
Successful investors understand that risk is a multi-faceted concept that requires a rigorous investment evaluation process and a fundamental analysis of potential investments. Also required is emotional intelligence. Investors need to have the discipline to set and adhere to long term goals, a mature practice of patience and understand the importance of having a long term investment horizon. In investing, risk is not to be avoided, but embraced and managed correctly.
The Whitnell Way is not to predict the unpredictable, but through research and analysis to secure a margin of safety that gives investors the patience and confidence to adopt the long run outlook for their investments whatever the state of the market.
Note: We have gathered the information contained in this report from sources we believe reliable; however, we do not guarantee the accuracy or completeness of such information. You should not assume that any discussion or information contained in this market commentary serves as the receipt of or as a substitute for personalized investment advice from Whitnell & Co. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.