Economic and Market Environment

10 Important Charts & Tables

And Their Relevance for the Long Term and Short Term

1. Inflation & Interest Rates
2. Inverted Yield Curves
3. Unemployment & Recessions
4. Corporate Bond Spreads
5. Consumer Confidence
6. Productivity
7. The Importance of Dividends
8. Dividends & Successful Investing
9. Long-Term Price-to-Earnings Multiples
10. Long-Term Stock Returns

• Inflation and interest rates trend in the same direction. This is logical since inflation reduces purchasing power, thus requiring higher bond yields to compensate. As inflation rises, bond yields rise.
• The future trend of interest rates will be largely determined by the future trend of inflation. This is why for bond investors and investors in general, achieving a low and sustainable level of inflation is so important.
• The Federal Reserve (Fed) is targeting 2% inflation. We believe it will be achieved, thus providing a more stable environment for bond investors. For common stock investors, low interest rates are also important as they positively impact stock valuations.

• In the past, inverted yield curves (when short-term interest rates are higher than longer-term interest rates) have been accurate predictors of recession. Inversions only occur when monetary policy is restrictive, as now.
• Currently, the validity of this indicator is being called into question. It is possible that the inverted yield curve signal will fail because Covid had such an unusual effect on the economy.
• Note that the time lag between inversions and recessions can be lengthy.
• The fact that yield curve inversion as a recession indicator is inherently logical encourages us to not yet discount its warning signal.

• Similar to the inverted yield curve warning, rising unemployment should be monitored closely as a recession warning signal.
• The chart indicates that when unemployment starts rising it continues to rise, and in the past, recessions have followed when unemployment increases were fairly modest.
• In this cycle, unemployment has risen from a low of 3.4% to its current rate of 4%. This is almost triggering the “Sahm Rule*” which has been very accurate in its recession predictions in the past.
• We consider the inverted yield curve and unemployment warnings to be sufficient to keep us on recession watch.

*The Sahm Rule was developed by former Fed economist Claudia Sahm - If the national unemployment rate rises by 0.50 percentage points or more, relative to its low during the last twelve months, it predicts a recession soon.

• Unlike the inverted yield curve and unemployment recession indicators, corporate bond spreads are indicating little concern over weaker economic activity. No recession warning here.
• Bond spreads, the difference between corporate bond yields and U.S. Treasury yields, almost always widen going toward or into a recession, but not now.
• Spreads are very low, reflecting confidence in corporate balance sheets and the ability of companies to navigate through economic weakness.

• The U.S. economy is consumer-based. Some 70% of Gross Domestic Product (GDP) is accounted for by consumption. Consumer confidence is a key figure in the consumer’s willingness to spend.
• Oddly, in today’s economy, with unemployment low and the stock market doing well, consumer confidence is lower than normal.
• This condition may reflect the lingering effect of high inflation on consumer attitudes. This is one reason it is so important for inflation to return to low and sustainable levels.

• Labor productivity does not receive a lot of attention, but it is a key ingredient in future economic growth.
• GDP, which measures U.S. economic growth, is created by more people coming into the workforce through population growth and immigration, plus productivity growth. In other words, more people working, and working more productively.
• Currently, population growth is slowing, immigration is growing, and productivity is on-trend.
• Artificial intelligence is currently a hot topic. It holds the prospect of higher economic growth through larger productivity gains. If so, it could herald a period of higher GDP growth and rising standards of living.

• Historically, dividends have played a crucial role for successful investors.
  
  
  • Dividend growers and initiators over the last four decades have performed better than dividend cutters or eliminators, non-dividend payers, and dividend payers with no change.
  • Dividend growers and initiators also carry less risk than the other categories as measured by standard deviation.
  • Dividend growers and initiators’ success can be largely attributed to a favorable combination of upside participation in strong markets and downside protection in weak markets.

• Companies that paid dividends over the last four decades have materially outperformed non-dividend payers and companies that cut or eliminated dividends.
• This historical trend illustrates the power of consistency and the ability of companies to maintain and grow dividends through a wide range of economic circumstances.
• We believe consistent dividend performance will continue to be an important feature in achieving attractive returns over the long term.

• The level of stock prices is determined by two things: corporate earnings and the value investors place on those earnings (P/E ratios).
• Over the last three decades, P/E ratios have ranged from a high of 24 in 2000 to a low of around 10 in 2011. Currently, they stand nearer to the high end at around 23x earnings.
• While high P/Es can be a warning of lower stock returns to come, stagnant P/E ratios can be countered by strong earnings growth. In general however, low valuations have typically set the stage for above-average returns.
• High valuations are not always a recipe for poor returns, but at current levels common stock investors should have realistic expectations for returns over coming years.

• Fact: over 95 years, the stock market has been in a rising trend.
  
  
  • 26 down years
  • 69 up years
  • Longest string of down years: four (during the depression)
  • Longest string of up years: nine (following the Great Financial Crisis)
• Stocks can be volatile and are subject to periodic downturns, but because the underlying U.S. economy’s natural state is expansion, corporations are able to capitalize on that growth with growing earnings and dividends.
• Down years occur randomly and are difficult to predict. Also, it is well documented that a large percentage of stock returns come from a relatively few days of dramatic returns. Investors don’t want to miss out on these, so they are better served by committing to long-term participation in the upward sweep of U.S. equities.

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