My father, Frank Bragg (aka Papa), conspired with my son Charlie (12) to convince my wife that Charlie needed a puppy for his birthday. Charlie gave us his birthday list back in July. At the top of the list: a puppy. Alice quickly informed Charlie that we were not getting another dog, especially a puppy. “We already have a wonderful dog [it’s true] and there is no way we are doing that puppy thing again.” Not finished, she reeled off a few more reasons why the idea of getting a puppy was a non-starter. “In addition to already having a dog, we have two goats, two pigs, two donkeys and a bunch of chickens to care for. You’ll go to school, your father will go to work and I’ll bear the brunt of caring for this puppy—taking him outside to potty every three hours, cleaning out his crate after he makes a mess, taking him to the vet for all those shots puppies need. He’ll bark and whine all night, chew up everything we own and jump all over us and any visitor who stops by the house. We’ve been through all that enough times already. And who will train him? Now go think of something else to put on your birthday list.”
That seemed to shut Charlie down for about a week but then one day he came home with two well-worn dog-training books, Family Dog and Water Dog, both classics written by Richard Wolters back in the sixties and still in print today. He held up his books and proceeded to make a remarkable argument for getting a puppy. “Everything I need to know is right here in this book, Mama. I will train this dog and I will take care of him. He and I will be best friends. And I need a friend. My brothers and sister will all be in college soon and I will need some company.” And then the clincher, “Mama, I know you feel like we already did the animal thing with the dogs, the donkeys, the goats and stuff, but I was a baby when all of that happened. Just because I am younger shouldn’t mean I miss out on the chance to have my own pet.”
Alice was moved. “Wow, Charlie, that is quite an argument for a boy your age. How did you come up with all of that? And where did you get those books?” It was then that we learned that Charlie had been huddling with his grandfather, hatching this plan to get a puppy. He said, “Papa gave them to me. Papa says every boy needs a dog. He said he had a dog when he was a boy and he said that Daddy had two beagles when he was a boy. And Papa said he would help me train him and that you wouldn’t have to do anything.”
Alice caved. Charlie got a black lab puppy. As Alice predicted, it has taken over our lives (especially hers). She’s been a wee bit testy of late. Charlie has never been happier.
Thinking back on it, I must say that Alice made a convincing case for not getting a puppy. Prior to Charlie turning us both with his heart-string-tugging haymaker of an argument, she had actually won me over to her side. She was obviously scarred with memories of the last puppy we raised. This one will bring scars too. But we’ll make it through.
Speaking of scars, the recent performance of the stock market might lead one to believe the scars of the financial crisis are finally fading. The market advance that began over ten years ago in March of 2009 has often been described as the “most hated bull market in history,” so scarred were investors by the financial crisis when US stocks fell more than 55%. For years after the rally began, investors simply doubted that the market was on solid footing and expected another big crash.
Even as the economic expansion continued and the market rally reached new heights, it seemed that a healthy respect for risk kept overly-bullish emotions at bay and market valuations in check. But now investors seem to possess a bit more fortitude as they drive the market to one record close after another. Call it grit, call it guts, or, leaning heavily on my thesaurus, call it moxie or maybe even pluck. Whatever you call it, since the end of July when it seemed the pundits were trying to talk us into an economic recession, the market has jumped almost 14% and for the most part, it has been a one-direction rally. Price-to-earnings (P/E) multiples, price-to-book (P/B) multiples and other valuation measures show the market now trading above the average of the last 25 years.
In delivering this performance, the market has climbed the proverbial “wall of worry.” As Matt DeVries points out in his year-end Market and Economic report, the US manufacturing sector remains weak, capital spending is expected to fall in 2020, the trade spat with China remains mostly unresolved, economic growth remains anemic in Europe and the UK, the Chinese economy continues to slow and US CEO confidence is low. In addition, we have tremendous political uncertainty in the US, first with the unresolved impeachment proceedings and even more significant, with the election just ten months from now.
And earnings? We always point out that stock prices are driven by corporate earnings so earnings must be up, right? Wrong. Quarterly S&P 500 earnings have been flat since the second quarter of 2018. While final numbers aren’t in, estimates are that earnings only grew by about 1% for the full year in 2019. So, are the moxie, pluck and fortitude recently on display by investors proof that the scars of the financial crisis are healed, that respect for risk has gone bye-bye and that overly-bullish emotions now control the market? We think not. At least not yet. There is always the chance that we could experience a market melt-up where emotion does take over and where investors become irrational. But we don’t think we are there yet.
Instead, we think the market is forecasting continued positive economic growth in the US, continued low interest rates and low inflation, reasonable earnings growth (mid-to-high single digits for the S&P in 2020), a slight pick-up in economic growth in Japan and Europe, a clearer path to Brexit in the UK, slightly more progress with China on tariffs, certainty regarding impeachment (Senate won’t convict) and most important, a very strong US consumer.
I’ll say a bit more on the consumer here since the consumer is the big driver of the economy, representing almost 70% of US economic output. With unemployment at a 50-year low of 3.5%, jobs are plentiful and wallets are bulging. Household net worth is at an all-time high while the consumer debt service ratio (consumer debt payments as a percentage of disposable income) is very healthy, thanks to low interest rates. Consumers are therefore confident. The 2019 holiday shopping season set records, and barring an unexpected shock like a dramatic escalation of the current clash with Iran, the spending is expected to continue into 2020.
The market is telling us that the positives outweigh the negatives, that economic conditions are pretty good. This is quite a different narrative than was generally accepted throughout the first six to seven months of 2019 and there is a good lesson in that. Investors entered 2019 believing the Fed was going to continue pushing interest rates higher. Recall that the market sold off dramatically in the fourth quarter of 2018 in response to the Fed’s aggressive tightening. In an abrupt change of course, not only did the Fed not raise rates in 2019, they lowered rates three times. Last summer, investors worried that a messy Brexit, the trade war with China and the slowing economies of Europe and Japan would push the US into recession. This scenario didn’t materialize and investors who brushed off dire warnings and gloomy headlines and remained invested were rewarded handsomely.
So, Benton, what about the elephant in the room? Oh yes, the election. It looms out there doesn’t it? As we mentioned last quarter, it will be a turbulent year for investors—heck, turbulent for everyone, investor or not. I think the word Phillips Bragg used in his commentary last quarter was “shrill.” Voices will be shrill in 2020. Obviously the outcome of the election will have repercussions for the market given the stark differences in the platforms of the two parties. We’ll know more (and write more) in a few short months as the primaries narrow the field of Democratic contenders.
In summary, investor scars from the financial crisis have faded but still linger. Recent outstanding returns in the stock market reflect expectations that economic conditions will continue to be favorable for business. 2019 was an outstanding year for markets; don’t expect a repeat in 2020. At Bragg we are rebalancing portfolios, recognizing that the future is unknown. The business cycle lives on and periodic market declines are a certainty. Sometimes they’ll be scarring like that of the financial crisis but if we own an appropriate portfolio and maintain discipline we’ll make it through those markets and be rewarded.
I better stop here and go take the dog out. Please let us know if you would like to discuss your portfolio or your planning. We greatly appreciate your trust in Bragg and wish you the very best in the New Year.