The international economic picture in 2016 was marked by tumult in Europe as ‘Brexit’ rocked the continent, growth slowed in China, and central banks deployed every tool in their arsenal to try to spur their economies in the face of sluggish growth. 2017 proved to be calmer economic waters. The Organization for Economic Cooperation and Development (OECD), an organization that tracks the economic developments in 45 countries, showed that all 45 economies grew in 2017, and 33 of those 45 grew at a faster pace than in 2016. That marks the largest number of nations with accelerating economic expansion since 2010.
Stock markets around the world responded positively to the broad-based international economic expansion in 2017, with international small-cap equities leading the way, growing by 30%. Unlike in the US, where stock market gains have outpaced corporate earnings growth, international equities have grown at a more tempered pace. Despite strong gains in 2017, there appears to be additional room for growth in 2018 as international company valuations remain quite attractive.
Central bank policy continues to be a focus in both Europe and Asia. The European Central bank plans to purchase $30 billion in assets per month through September 2018, down from $60 billion per month. This signals that the ECB believes that their economy is gaining footing and needs less assistance than in 2017. Japan will continue its quantitative easing efforts in 2018 as well.
Two of the world’s largest emerging economies, India and China, are displaying promising economic signs for 2018. All else being equal, investors feel more confident investing in nations with stable political environments than not, and both nations are benefitting from a more reliable economic outlook thanks to consolidation in political power.
India’s Prime Minister, Narenda Modi, has overseen massive economic reforms over the past couple of years. India’s economy has been historically difficult to track because many of the nation’s financial transactions were made with cash, and were not reported and taxed properly. in 2016, Modi boldly demonetized the 500 and 1000 rupee notes typically used in cash transactions. In 2017, he implemented a value-added tax. These changes have led to far more transactions taking place in the regulated economy, and more fair and efficient taxation.
China will likely continue to experience a slower economic expansion than in the past, but growth drivers are changing rapidly. The world’s largest economy continues to move from a closed, goods-based economy focused on metals, energy, and chemicals, to one that is open to foreign investors and export-heavy. New focus in technology and renewable energy promise to be long-term growth drivers.
International stock market returns have significantly lagged US returns since the financial crisis in 2008, but with US stock market valuations continuing to climb, international equities could prove to be an attractive place to look for growth. Increased transparency in financial markets, central banks’ measured use of quantitative easing, and reasonable investment valuations are all ingredients that point to a solid 2018 in international markets.
Written by Blake Bitz, Investment Advisor Representative
With the markets skyrocketing to all-time highs, many are wondering if gains can be sustained, and if the US economy can support this elevated market environment. The good news is that the economy appears to be on sound footing. Unemployment is at its lowest rate in nearly two decades, wages are rising, U.S. companies are raking in record profits, and housing prices continue to rise.
US consumers who are optimistic and confident in their own economic outlook are vital in revving up the overall US economic engine. Spending drives our economy, and the more goods and services that people purchase, the better the results are for businesses. Flourishing businesses raise wages and hire new workers as their demand increases. As wages rise and unemployment falls, folks become more optimistic and tend to spend more, perpetuating the cycle. At the end of October, Bloomberg reported that consumer confidence is at a 17-year high, and as a result, folks are increasing spending.
A big contributor to the high consumer confidence levels is the U.S. unemployment rate, which currently sits at 4.1%. This is a rate not seen since February 2001, and a level that economists consider to be ‘full employment’. In addition to low unemployment, wages are rising at about 2.5% year-over-year as businesses pay to retain key talent. That wage growth number is rather low, and indicates that the economy still has some room to grow; when wage growth reaches high levels, it can indicate over-enthusiasm in the economy, which can ultimately lead to negative turnarounds.
The Housing Market
The housing market continues to face a situation in which there is extremely low supply, but high demand. In this environment, housing prices have risen dramatically in the last couple of years. A large chunk of that demand is coming from millennials eager to transition from renting to homeownership. The government has encouraged this trend by offering programs that allow first-time home buyers to purchase homes with little down and low interest rates. With inventory at such low levels, however, few are successful in closing on a home, and those that do are forced to agree to loans that are higher than they might have hoped. This trend may persist for some time, as folks remain wary of putting their house on the market when they are unsure they will be able to buy another somewhere else. Additionally, homebuilders are neglecting the lower end of the market in favor of building high-value homes that bring them higher margins.
What does all of this mean for the stock market? The S&P 500 is currently trading at a 25.3 P/E ratio, a historically high number*. Market gains have been driven by enthusiasm about the strong economy, and the promise of reduced government regulation as well as the potential for lower corporate tax rates. There is a correlation between market value and market returns in the following year; while it is difficult to accurately predict returns, the expectation is low to moderate returns in the best case scenario, and a downturn in the worst case scenario, with the median expectation being negligible to small returns. Given that the economy is strong, consumer confidence is high, and companies are expected to post positive returns next year, we don’t anticipate an exceptionally large selloff. More likely, market performance will be lethargic.
Beginning in January 2018, we will begin to publish monthly articles, and plan to provide quarterly coffee lectures to give clients and community members the opportunity to join us for in-depth presentations on a variety of investment topics. Stay tuned for more information!
*Check out the past articles “What is a Company Worth?” and “What is Fundamental Analysis?” for more information on P/E ratios and other valuation metrics.
Written by Blake Bitz, Investment Advisor Representative
Last quarter, we explored the broad definition of fundamental analysis, and how perhaps the most successful investor of a generation, Warren Buffett, amassed a fortune using this technique. In this article, we’ll look at the ways in which fundamental analysis is used to determine a company’s value that we can then use to make informed investment decisions.
What determines a company’s value? The truth is, it is very difficult to determine a company’s exact value, which is why investment opportunities arise in the first place. If everyone knew exactly what a company was worth, and exactly what it would be worth in the future, the company’s stock would trade at that exact price at all times, and no money could be made. Our goal is to get a close estimate, and then look for any large discrepancies between the value we calculate and the company’s stock price.
In the simplest terms, a company’s underlying value can be described by its book value. Book value is defined as the amount of money per share that an investor would receive if the company shut its doors today, liquidated all assets, paid all debts, and then distributed the difference to shareholders. Occasionally, we will find companies whose stock prices are trading below book value. As long as there isn’t something fundamentally wrong with the company, these can be good investment opportunities since we would expect that in the long run, the stock will at least return to the value that a shareholder would receive if the company ceased operations.
There are other factors in the value equation, and this often leads to stocks trading well above book value. Things that add value to company are safety of the investment, earnings growth, industry competition, scalability, etc. A large component of a company’s value is its financial health. A company that has ample assets and reasonable debt levels provides confidence that it is prepared to withstand a potential downturn in its industry, and shows that the company is in a position to make strategic acquisitions that can make them competitive in an ever-changing business environment. It is valuable to have reasonable assurance that a company you own will not go bankrupt if the economy or its industry experiences a downturn. For this reason, on average, companies that are safer investments command higher stock prices.
A company’s earnings are another extremely important part of the value equation. With a healthy balance sheet already in place, a company can increase its value by turning a profit each year. A positive net income is the lifeblood of any company, and it is what allows a company to grow and expand, to meet its debt obligations, and to invest in its future success through research and development and upgrades in infrastructure.
Earnings are used in a key valuation metric that every fundamental analyst uses: the price-to-earnings ratio (P/E). This is calculated by dividing the company’s stock price by the company’s earnings-per-share over the past year. In general, lower P/E ratios indicate better value, and if a company’s P/E is lower than its historical average, it can indicate a good investment opportunity because we expect that the stock will return to the average P/E in the long run. P/E is reduced when either the company’s stock price declines, earnings increase, or both.
Sometimes a company’s P/E is at or above historical averages, but we expect earnings growth in the coming year. Is this a good investment scenario? We can quantify this situation with what is called the forward P/E ratio, or the P/E we expect the company to have one year from now if the stock price were to remain the same. Forward P/E can be calculated with projected earnings that companies often report in their annual reports. If the forward P/E is lower than the historical average P/E, it can indicate a good investment opportunity.
There are many valuation metrics that fundamental analysts use to determine a company’s value, such as price-to-sales, price-to-cash flow, return on investment, etc. They all serve to create a full picture of a company’s value that allows us to make informed investment decisions. A fundamental analyst is searching for companies whose stock price has taken a hit, but has a solid balance sheet, is projected to achieve increased earnings in the coming year or years, and has valuation metrics that are currently below historical averages. If all of these fall into place, it is very likely that a good investment opportunity has been found. At JR Young, we are continually searching for these kinds of investment opportunities in order to build portfolios full of companies that have good growth potential.
Written by Blake Bitz, Investment Advisor Representative
Performing thorough analysis of various investments is important to build a portfolio that minimizes risk, while maximizing potential profit. Different members of the investment community will give you different answers when you ask them what distinguishes a good investment from a bad one, but most fall into one of three camps: those who use fundamental analysis (trying to measure a company’s intrinsic value), those who use technical analysis (analyzing stock chart patterns for entry and exit signals), and those who use a mixture of the two.
Investors utilizing each of these three schools of thought have amassed tremendous fortunes, but perhaps one of the wealthiest and most famous investors of our day, Warren Buffet, favors fundamental analysis and uses it almost exclusively. If one of the wealthiest people in the world favors a certain investment analysis tool, it probably pays to familiarize ourselves with it!
Fundamental analysis is defined as a method of evaluating a security in an attempt to measure its intrinsic value, by examining related economic, financial, and other qualitative and quantitative factors (Investopedia). The underlying idea is that as rational beings, we will pay more money for things of greater value, and less money for things of lesser value. Fundamental analysis attempts to reveal the value or predicted future value of a given company so that investors have an idea of how much they should be willing to pay to own that investment. In the short term, a company’s share price often bounces around in an erratic fashion, sometimes becoming cheap and sometimes expensive relative to the company’s true value. In the long run, however, a company’s stock price and true value tend to move in lockstep. If a company’s stock price is less than the value determined through fundamental analysis, it is probably a good buy, because in the long run we would expect the share price to return to parity with the company’s true value.
Warren Buffett amassed, and continues to grow his fortune on this principle, the most famous example being his investment in Coca Cola. The stock market crashed in 1987, and many stocks prices slid to levels well below the underlying company’s true value. Buffett recognized that although the company’s stock was struggling, Coca Cola remained incredibly strong with excellent financial health, strong earnings, global reach, and little competition. In 1988, Buffett purchased more than $1 billion of Coca Cola, and over the next 27 years, it grew to more than $16 billion. He recognized that Coca Cola was incredibly undervalued and took advantage.
At JR Young, we have taken Warren Buffet’s lead, and use fundamental analysis as the cornerstone of our analysis strategy. We believe that it is a sound investment philosophy that has served investors well over many years. In the next article coming June 1st, we will look at some of the ways we perform this analysis, and how we determine a company’s value. Stay tuned and feel free to contact us to suggest topics for future articles!
Written by Blake Bitz, Investment Advisor Representative
For many, the start to a new year brings with it a great opportunity to resolve to improve our health and fitness. A new year can be a great opportunity to evaluate and improve our financial ‘fitness’ as well. Whether just beginning your career, or planning to soon retire, there are many simple strategies that you can implement to make sure that you are reaching your financial goals. Here are three to get you started:
How great would it be if for every push-up you performed, you received the health benefits of two push-ups? This exists in the financial world in the form of Employer 401(k) matching programs. A great majority of employers offer some form of these plans, which usually involve the employer committing to match some percentage of the employee’s salary contribution to a retirement savings account. Nearly 8 in 10 workers take advantage of these programs, but 1 in 4 of those are missing out on the full company match by not saving enough. Among these employees, on average, $1,336 is left on the table each year, or an estimated $24 billion all together. Committing to take full advantage of your employer matching program can mean potentially hundreds of thousands of extra dollars in your retirement account over the course of your career.
Just as it is important to perform a variety of exercises to strengthen the entire body, it is important to own a variety of different investments to have a strong portfolio that will stand up to unpredictable market movements. It is difficult to accurately predict which parts of the economy will perform well in a given year, so it is important to own investments that benefit from different sectors of the economy. Making sure your portfolio is properly diversified helps to minimize the risks of investing, while maximizing the chance that your long-term financial goals can be safely reached.
We all know that staying consistent with a diet and exercise program brings success. The same is true with investing; those who choose long-term investments and stick with them through the ups and downs of the market tend to reap greater returns than those who try to buy and sell frequently. A recent MorningStar study found that investors who tried to “time” the market during the downturn and rebound of 2008 and 2009 experienced on average a 1.4% point lower return than the market average; that means that, on average, those who stayed the course during the market downturn did better than those who sold and repurchased their investments.
If you are seeking advice regarding your financial situation, feel free to give us a call at J.R. Young P.C. at (541) 484-1211.
February 1, 2017
Written by Blake Bitz
Published in the March 2017 edition of North Gilham Living magazine, pg 22