Allen: Welcome. My name is Allen Gillespie, and I’m the Chief Investment Officer for FinTrust Capital Advisors, and today’s host. You’re listening to “FinTrust: From the Desk Of Podcast,” our podcast about markets, life, and things financial.
The Hank Williams, Jr. Market. We’ve received a lot of questions from advisors and clients regarding current market conditions because people are worried about inflation, higher interest rates, higher energy prices, higher food prices, the war in Ukraine, and the risk that China invades Taiwan. So, in this podcast, we take a look at today’s, “Hank Williams, Jr. Market,” and what it means for investors.
In his 1981 classic, “A Country Boy Can Survive,” the country singer, Hank Williams, Jr., wails that the interest is up and the stock market is down, and you only get mugged if you go downtown. The song was released to the public in January 1982. At the time, the US and Russia were deep into the Cold War. The inflation rate was 8.4%, similar to last months 8.4% inflation rating. In 1981, the economy was also in the middle of a severe recession, but in 1982 the stock market would make a generational low during that midterm election cycle. There’s no question that higher interest rates and higher oil prices today are negatively impacting the economy and the stock market. U.S. Consumer accounts for approximately 70% of the economy. Higher interest rates hurt the interest-rate sensitive sectors of the economy, like housing and cars, and higher oil prices further cut consumer discretionary spending. Higher short-term interest rates negatively impact high growth, high price-to-earnings ratio technology stocks the most, and today, technology and communications companies make up about 35% of the U.S. stock market. To illustrate this, I will use one of today’s largest technology stocks, as you would intuitively think large companies would be less sensitive, Microsoft as an example of what we see occurring in the stock market. A few months ago, Microsoft had a price-to-earnings ratio of 35. If you reverse the price-to-earnings ratio, you get the initial earnings yield on a stock. So when you divide the $1 of earnings by that price-to-earnings ratio of 35, you would find an initial earnings ratio of 2.86%. Today the P multiple on Microsoft has dropped to 30 as the stock has declined, so it’s earnings yield has increased by 48 basis points, approximately the same amount that the Federal Reserve recently increased interest rates. That’s the short-term effect. In the long run, Microsoft is still projected to grow. In fact, it is projected to grow earnings 16% over the next year, and it has a 47% return-on-equity. If a company grows by 16% per year, under the rule of 72, it will double in size roughly every 4 and a half years. Historically, stocks have been able to increase and double about every 7 to 8 years.
In addition, the war on Ukraine has exasperated today’s inflationary pressures as the Ukraine is a large exporter of key energy, food, seed oils, and metals. As a result, Europe is scrambling to secure supplies from other locations around the world including the U.S. So all this is leading to higher rates of inflation, however, we see reasons for hope on the inflationary front.
To date, inflation has been driven by few key items, one of which has been used cars. Used cars prices shot up during COVID because production of new cars slowed dramatically. So as people would replace cars and interest rates were low, they could finance more cars plus they had stimulus checks for down payments, you saw a dramatic increase in used car prices. But as the supply chain comes back online for new cars, as stimulus payments wain and as interest rates increase, you’re seeing a fast moderation in used car activity and prices. Home prices have also been a driver of the inflationary headlines and are the largest input. Obviously COVID led to the mass migration out of the urban centers to more, less densely populated areas where housing supply was not as great. This also increased prices in the headline inflation numbers, and the low interest rates again help stimulate a lot of that demand. But now that mortgage rates are up, you’d expect to see slowing of activity in the housing markets.
Energy prices are also up. Part of this is about policy design, as new Green Deal policies seek to keep energy prices high to encourage substitution and conservation as we move away from hydrocarbons to more electrics, solars, and renewables, but also the war in the Ukraine has exasperated. But historically, energy prices do moderate as the economies slow, so we’d expect to see a moderation of energy prices as well, though these will prove to be stickier because of geopolitics. Energy prices in turn, impact food prices which we do expect to remain elevated for a while, but these are smaller components of the CPI. So, net-net when you look at these key components, we think the inflationary headlines are reaching their peak and will begin to slow in the months ahead, though there will be places of stickiness.
So, from a financial planning standpoint, you know, everything we’ve seen is well modeled for; the average decline for stock market in a given year is about 15% over the last 40 or 50 years, so pretty typical activity. We don’t see signs of recession, the yield curve is not inverted, though interest rates are up so that is impacting stock multiples at the moment, and inflation is higher. So we do need to see improvement on the inflationary front and the market does need to be able to see an end to the interest rate increases to get more comfortable that growth will matter in the long run. But, you know, over time, growth does matter more, interest rates are a cyclical variable, but they do have short term impacts and we are seeing that. But, as investors, it’s something we model for, it’s something we plan for, and something that comes with the territory of being a long-term investor. As always, if you have concerns, feel free to reach out. We’d be happy to speak with you. Thank you, bye.
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