Skip to main content

Sound Advice: October 14, 2020

“I like the dreams of the future better than the history of the past.”

                                                                            Thomas Jefferson

History is a useful, though not infallible, guide to what lies ahead. Invariably, excess in one direction is followed by offsetting movement in the other direction.  Strength is followed by weakness and vice-versa.  Within the universe of investments, there are those that do better than the averages and those that do worse.  When interest rates are low and credit is loose, the stage is set for an acceleration of growth.  When interest rates are climbing and credit gets tighter, the brakes are being applied to economic advances.

Stocks tend to rise when investors expect earnings to rise.  They weaken when the view ahead is less rosy.  Bonds rise when interest rates are dropping. Typically, this takes place when monetary policy eases or when investors’ fears prompt a flight to quality.  As business conditions improve, monetary policy tends to tighten, causing bond prices to fall and bond yields to rise.  As interest rates change, the impact on prices is greatest on bonds with the longest maturities and least on those maturing in the near future.

At all times, the issue is what lies ahead, not what has already happened. More specifically, what investors do today reflects what they expect to happen tomorrow. The reality that follows is often quite different from what was expected. Changes in investor psychology, and their impact on market prices, tend to be far greater than the fluctuations in underlying fundamentals they are supposed to be reflecting. 

A company with an unblemished record of annual advances may be viewed as one with below average risk and above average earnings predictability, but that history will do little to dampen the impact of the speed bumps that loom ahead. Companies with checkered records will generally be accorded leaner valuations, primarily due to the increase in perceived risk.

One of the better examples of the need to look ahead is cyclical companies. Those are companies that regularly move through periods of lean and rich results. Those that produce raw materials such as steel, paper, and fertilizer are of this type. When their profits are in a trough, their shares tend to receive the richest valuations (price-earnings multiples) since investors are aware that profits are atypically low and will rise during the next boom cycle. Conversely, when profits of these companies are peaking, valuations will be low, reflecting the likelihood that a downturn will soon follow.

N. Russell Wayne, CFP®

  

Comments

Post a Comment

Popular posts from this blog

Sound Advice: May 13, 2020

Reality Check

 On the heels of the market plunge of late February and most of March, investors did a sharp about-face in April, bidding up shares at one of the fastest rates in recent history.  Although this recovery probably provided at least temporary comfort from the plunge, it would be unreasonable to view the rebound as a sign that things are all better.  They are not.
For one thing, we are now in the midst of earnings reason, when companies report their quarterly results.  Some may have good news for the March quarter, but as we move through the current calendar quarter, only a few will be able to show continuing improvement.  Against the broad backdrop of U.S. business history, the months just ahead will almost certainly prove to be among the worst, from the standpoint of year-to-year comparison.
With more than 30 million people filing claims for unemployment insurance, it would be difficult to expect anything other than bad economic news.  Who knows how many of these folks will go…
Post a Comment
Read more

Sound Advice: July 8, 2020

Jobs Are Up, But So Are New Infections
Through the spring months, most of the economic data was extremely negative, with record declines in employment and consumer spending.  The speed of that decline had no modern precedent.
We are now in a recession.  
The shortest recession on record occurred in 1980 and lasted just six months.  Second place goes to a seven-month recession in 1918-19, which was tied to the Spanish flu pandemic.  The big question is: When will this recession end? Given surprisingly strong data in May, April may have been the bottom of this economic cycle.  If so, it will have been the shortest recession on record.  With massive support from the Federal Reserve, the federal government, and the reopening of previously closed businesses, employment surged unexpectedly.  At the same time, pent-up demand, stimulus checks, and generous unemployment benefits led to a reacceleration of commercial activity. Still, not all is rosy.   In his recent testimony before Congress, Fed Chie…
Post a Comment
Read more

Sound Advice: July 22, 2020

Fixed Income: In a Fix
Typically, the construction of an investment portfolio has begun with an approximate balance of 60% in equities and 40% in fixed income instruments.Fixed income generally means bonds, but that includes bond funds and exchange-traded funds holding bonds.The equity portion is intended to be the driver of capital appreciation over extended periods of time and the fixed income portion is supposed to provide stable, albeit more moderate ongoing rates of return.
The theory behind this approach is that as the time periods measured have lengthened, the relative risk of holding equities has diminished while the returns they have generated have been higher than those of other asset classes.What equities do in the short term, even a year or two, is often anybody’s guess.
To the extent that fundamental analysis can help toward determining future equity values, investors need to look ahead three, four, five years or more before reasonably expecting that the odds will be on thei…
Post a Comment
Read more