“That Was the Week That Was”
by Jeffrey Saut, Chief Investment Strategist, Raymond James
May 6, 2013
Informally the TV show, “That Was The Week That Was,” is referred to as TW3 and was a satirical comedy program first aired in the early 1960s. The program was considered a lampooning of the establishment. At the time it was considered a radical departure from legitimate television, but it set the stage for many more such radical departures. I revisit TW3 this morning because I have had so many requests for a formal repartee of a number of last week’s Morning Tacks woven into a more formal strategy letter.
I began last week with Monday’s comments that read:
Clearly, this performance pressure is currently playing on the ‘street of dreams’ as the D-J Industrials and the D-J Transports have tagged new all-time ‘highs’ over the past few months (yet another Dow Theory ‘buy signal’). Accordingly, I revisit Ralph Wanger’s ‘Zebra’ story this morning having returned from the RJFS National Conference where I interfaced with a number of portfolio managers (PMs) that are currently experiencing the same ‘performance pressures’ that many investors are feeling having missed the recent rally. Yet one of the most frustrating comments came from a PM that was almost fully invested, but is still woefully underperforming. His problem is he is fully invested in U.S. companies that generate more than half of their revenues outside the United States (Internationals). Surprisingly, companies generating more than 50% of their revenues inside the U.S. (Domestics) are outperforming the Internationals by a wide margin, as can be seen in the nearby chart (page 3) from the sagacious Bespoke organization. Indeed, the Domestics are better by 21.3% over the last 12 months while the Internationals are up only 8%.
On Tuesday I began the Morning Tack with a quote from my friend David Kotok, of Cumberland Advisors, where he noted the anger from the American public over the sequestration-induced TSA slowdown had caused the public to coalesce and demand a quick solution, which happened. I subsequently wrote:
Recall that I have said similar things about an angered electorate, and their collective need to change the status quo, since the mid-term elections of 2010. Indeed, I think the ‘sea change’ that occurred with those mid-term elections has ushered in a new assembly made up not of professional politicians, but rather having a business orientation. That sea change, I think, will evoke the election of smarter policy makers, and therefore smarter policies, with attendant more practical solutions to our nation’s problems. And, evidently the stock market feels the same way as the Dow Industrials continue to trade to new all-time highs. Still, most investors do not trust the current rally, which has been a detriment to the performance in their respective portfolios! As repeatedly stated in these missives, ‘I think there is a decent chance that a new secular bull market is afoot,’ and has given investors multiple ways to leverage their way into that potential ‘bull move’ over the past five months.
Wednesday’s missive was about the power of dividends. To wit:
As many investors know, the impact of dividends, and the growth of a company’s dividend over time, has a very large impact on the total return of any investment portfolio. The numbers go something like this. Since 1926 the total return on stocks in the aggregate has been ~10.4% per year. Roughly 5% of that return came from price appreciation and 0.9% from price-to-earnings (P/E) multiple expansions. However, the remaining 4.5% of that total return has come from dividends and the compounding of those dividends over time. That means ~43% of total returns have come from dividends, which is why I always harp on them. Recently, however, the ubiquitous question has become, ‘Hasn’t the theme of buying dividend-paying stocks become a very crowded trade?’ To answer that question, I hark back to the last era of financial repression that occurred after World War II. Indeed, post 1945 saw massive defaults on debts leaving the populace short of income. The CEOs of corporate America realized this and began increasing the payout of dividends on their company’s stock. This trend continued into the early 1960s, at which time the dividend-issuers in the S&P 500 were paying out some 70% of their earnings in the form of dividends and the SPX was trading at a P/E ratio of ~23x earnings. Now fast forward, the dividend-issuers in the SPX are currently averaging a dividend payout of ~32% of earnings and the SPX is trading at a P/E ratio of somewhere between 14 – 15x earnings. So no, I don’t think this is a crowded trade.
Because I was out of town speaking Wednesday night, our economist Dr. Scott Brown wrote Thursday’s Tack and noted:
While there is clearly a lot of political noise surrounding fiscal policy in Washington, the biggest factor behind the large deficit of the last few years is that we had a severe recession. Recession-related spending, such as unemployment insurance benefit payments, has been trending lower. Revenues have improved as the economy recovers (but remain far below where they would be if the economy were nearer its potential). It’s estimated that if the economy were near full employment, this year’s budget deficit would be about 2.5% of GDP – not especially large. The problem with the deficit is the longer-term outlook. Lawmakers have focused on trimming the near-term deficit (which is not a problem), but have largely ignored the long-term problem. As the FOMC noted in its policy statement, tighter fiscal policy is currently restraining the recovery.
I closed out the week with this quip:
I was sitting in front of the camera yesterday listening to the program while waiting to be interviewed when one Wall Street strategist was regaling the anchor of the program about why he thought the U.S. equity markets were overpriced. He stated that the S&P 500 is trading at 2.5x book value versus the rest of the world’s major equity markets being valued at 1.5x book. While he conceded the U.S. was likely ‘the best house in a bad neighborhood,’ he questioned if that was worth a 66% premium to the rest of the world. After screaming at my friend the anchor, who obviously could not hear me, I emailed her with this: I have often discussed such issues on your show. Firstly, the depreciation schedule in this country has a tendency to depreciate plant/equipment at a much faster rate than what the true useful life of such assets actually is. This means the stock market’s book value is probably understated by a substantial amount, implying the 2.5x book is an overstatement. Secondly, our accounting system fails to properly account for the accumulation of ‘intangible capital. In my client presentations I talk about intangible capital using the example of Apple (AAPL/$449.98/Outperform). AAPL spent a lot of money developing and perfecting iTunes. To be sure, AAPL can write off the research/development costs of that project. However, now that iTunes is perfected, what is it worth? The answer – it’s worth a lot, but AAPL cannot carry it on its balance sheet as an asset. When such intangible assets are accounted for, the view of our economy, and subsequent ‘book value,’ changes -- and it changes profoundly for the better. It shows we are saving and investing more, which is the defining feature of a modern economy. QED, our price to book value is not too high.
That leaves the call for this week: The April payroll figure was better than expected, but more importantly, not as bad as feared. Moreover, the +114,000 net revision to the two previous months suggests that the labor market is stronger than we thought. And on that news the S&P 500 (SPX/1614.42) leaped above the 1600 level as we have anticipated. I actually thought it would take three or four attempts to surmount 1600 like it has taken at past century marks (the ideal pattern can be seen in the chart on page 3). This week what we have to be vigilant for is a sudden decline that would potentially represent a false upside breakout. However, I am not expecting that since the equity markets have a full charge of internal energy.
