Timing is everything…except don’t attempt to time the market. If you were told at the beginning of the quarter after already watching the US stock market fall 20% in the preceding quarter that the economy was going to slow down, the yield curve was going to invert, the United Kingdom wouldn’t negotiate an exit plan to the European Union, the Mueller report would be released, and the tariff wars would continue, how would your portfolio look? Well, if you would have decided to go conservative and remove a lot of stock exposure, you would have missed out on a terrific quarter.
In the short run, there appears to be no rhyme or reason to the movements of the markets. This is a characteristic of an efficient market which is made up of many participants all trying to figure out what makes it tick. Will interest rates rise or fall? Will earnings continue to grow? What happens if we enter a recession? What about politics? What are the effects of the tax bill? How about tariffs? Hundreds of factors go into placing a value on the market. Not only that, market participants are trying to determine the answers to these questions months in advance. Needless to say, there are no easy answers; and so the market can meander in crazy ways.
After living through a particularly volatile six-month period, it is often good to take a step back and remember what matters when it comes to investing. In the long-run, the market is much less irrational. Stock prices follow earnings. It’s as simple as that. The chart below highlights this well. The blue line represents the stock market. The green line represents 20 times trailing earnings (multiplying earnings by 20 allows the two lines to be on the same scale). For the past 50+ years, the market and earnings twisted, turned, and danced together in a satisfying upward slope.
A couple of things pop out if you study this chart. There are two periods where the blue line didn’t do much for an extended period of time. From 1968 – 1982, the market went up and down and ended up about where it began. That’s a long time to not earn much from stocks. Notice, however, the green line marched ever higher during that period. Eventually, the market found its dancing partner and caught up. The second long stretch began in 2000 and lasted until 2015. That period witnessed two 50% bear markets. Notice that this period started with the blue line above the green line – the only time on the chart where this happens. This was the dot.com bubble, and prices were extended. So, while earnings were rather volatile during those 15 years (particularly during the Great Recession), they did end the period much higher than where they started. The blue line then fell back below the green line, and the dance continued.
Lastly, notice the two lines are almost on top of each other now. Also notice, this extremely volatile six months barely registers as a blip on this chart. So, where do we go from here? There are some concerns in the short run (See every question posed in the opening paragraph.) The odds of a recession are at least 50/50 in the next two years. How’s that for putting a stake in the ground? But, not all recessions are as harsh as the last one (in fact, nearly none are). Earnings may slow down, temporarily. However, I strongly believe earnings will be much higher in ten years than they are today. I’m not going out on a limb here. This chart provides strong support. I don’t know what the dance will look like between now and then, but I believe the two partners will be intertwined at a higher level in the next decade. As investors, isn’t that what we’re looking for?
At White Pine, we do everything we can to be tax sensitive. After a ten year bull market, nearly any sale of a stock holding in a taxable account will generate a taxable gain. Last summer, we took some chips off the table as a risk management strategy. Some of these holdings were long-term holdings that generated sizable taxable gains. Ironically, when the market fell in the fall, many have found they have to pay capital gains taxes despite the down market. As we mentioned at the beginning of the letter, timing is everything.
Anthony J. DiGiovanni, CFA
Chief Investment Officer