- It's reasonable to be concerned at high P/E multiples. Present high P/E multiples are being supported by low interest rates.
- The Fed appears fearful of any impact of interest rate increases on the share markets.
- Low interest rates make deficits more affordable, in a climate where neither side of politics can agree on measures necessary to cut deficits.
- Low interest rates have supported strong share market returns over the last 10 years.
- Low interest rates appear likely to continue into the foreseeable future, supporting a continuation of multiple expansion.
- Looking for more investing ideas like this one? Get them exclusively at Dividend Growth Income+ Club. Learn More »
Buy and Hold Has Reigned Supreme Over The Last 10 Years
Figure 1 - The inexorable upward march of the S&P 500
Ten-year chart per Fig. 1 above shows the S&P 500 index has grown from 1257.60 at December 31, 2011, to 4766.18 at December 31, 2021, an average yearly growth rate of 14.3%. It can be seen the index has been inexorably marching higher, despite occasional interruptions. Around 2016, there were many articles published on Seeking Alpha, and elsewhere in the financial press, discussing the possibility of a dreaded "Black Swan" event. The stock market got its Black Swan events in the form of an "oil shock" and Brexit, but recovered so quickly. History, in retrospect, will likely not judge these as Black Swan events. In my Sep. 12, 2016, SA article, "Mr. Market's Latest Irrational Panic - Oil Shock, Brexit Shock, Fed 'Paper Tiger' Shock, Déjà Vu", I concluded,
Whether or not the Fed squibs raising rates at its September meeting, the markets will likely go on to new highs.
Again on Feb. 22, 2017, in my article, "The End Of The Beginning," I summarized,
- The “Beginning Of The End”, “The 'Inevitable' Selloff,” and “How Scary Is This Valuation Chart” are just a few headlines of late.
- “Corporations were doing effectively no better in late 2016 than they were in 2011. Yet stock prices have now more than doubled since that time”, says Eric Parnell, CFA.
- I would contend it is not the “Beginning Of The End,” but the “End Of The Beginning” of a long period of lowered investor return expectations driving stock price levels.
- Do not misunderstand me. I do expect corrections and volatility, but structural changes starting in the early 2000s will keep investor return expectations low for the foreseeable future.
All through the first nine months of 2018 there was much talk of the stock market being in "bubble" territory. Under the weight of pressure of all this "bubble" talk, the market eventually capitulated, with a steep fall in the fourth quarter of 2018, as shown in the graph above. Again, the market quickly recovered and went on to post new highs. And then came COVID-19 in 2020. And once again the market quickly recovered and soon reached new highs. And also again there has been much discussion of the stock market being in "bubble" territory. Other factors potentially weighing on the market are discussion of Federal Reserve tightening and rate hikes in 2022 (see here and here). With all of this negative discussion, I did form a view the market might capitulate before the end of 2021, as it did in 2018. I also formed a view any capitulation would likely be only temporary as in late 2018, early 2019. There was a mild pause and correction in third quarter 2021, but not anything like a bursting of a "bubble." In fact, Figure 1 shows the growth in the index has accelerated over the last two years despite COVID-19. The main takeaway from the foregoing is, a philosophy of "Buy & Hold" has proven very rewarding over the last ten years. But will Buy & Hold reign supreme over the next ten years? Before answering that question, I need to provide some additional analysis.
A Closer Look At Share Index Movements
In Table 1 below I include more recent movements in the S&P 500, together with movements in two other indexes.
Appropriately for a "Dividend Growth Income+ Club," along with S&P 500, I have included S&P 500 Dividend Aristocrats Index and the Dividend Growth Income+ Club's own index in Table 1 above. The Dividend Growth Income+ Club Index is based on 127 dividend-paying stocks, which include most of the dividend aristocrats (REITs and certain others are not included). As discussed above, the S&P 500 was supposed to be in bubble territory at September 2018. And yet, Table 1 shows the S&P 500 has grown by an average of 16.3% per year from September 2018 to end of December 2021. The S&P 500 has substantially outperformed the other two indexes in Table 1. This is not surprising as the S&P 500 includes the handful of mega stocks which have boosted returns for the S&P 500. On a total return basis the dividend stock indexes would be expected to improve compared to the S&P 500, but the S&P 500 would still be a clear winner. Walking through the movements in Table 1 -
- From Sep. 28, 2018 through Feb. 21, 2020 (immediately prior to the plunge in the stock market due COVID-19), the DGI+ Club index outperformed the other two indexes, with cumulative growth of 15.3%.
- The COVID-19 impact at Feb. 21, 2020, was felt the greatest in the S&P 500 Dividend Aristocrats index with a fall of 35.1%, while S&P 500 and DGI+ Club indexes fell by similar amounts of 33.0% and 33.9% respectively.
- By Sep. 30, 2020, the S&P 500 index was above Feb. 21, 2020 levels, and the other two indexes were approaching those levels.
- By Dec. 31, 2020, S&P 500 index was outperforming the other two indexes, with cumulative growth of 28.9% since Sep. 28, 2018. DGI+ Club index was up 24.5% and S&P 500 Dividend Aristocrats lagged, up 19.7%.
- At May 10, 2021, DGI+ Club index reached 42.8% above Sep. 28, 2018 level and did not reach or exceed the 42.8% gain level again until Jul. 27, 2021. Over the same period the S&P 500 Dividend Aristocrats index fell 1.2%. But, the S&P 500 index increased by 5.1% over this 2.5 month period. Was this the market moving away from the security of dividend paying stocks in favor of higher risk growth stocks?
- There was a minor market correction around the end of Sep. 2021, with the S&P 500 falling by 2.1% from end of Jul. 2021 level. The S&P 500 Dividend Aristocrats and the DGI+ Club indexes fell by 4.0% and 4.5% respectively over the same period.
- The market surged back strongly after the Sep. 2021 dip and by end of October all three indexes were above Jul. 2021 levels.
- The surge in the market has continued through the end of 2021. Annualized growth rates in Q4 2021 were 32.2% for S&P 500, 28.1% for S&P 500 Dividend Aristocrats, and 25.6% for Dividend Growth Income+ Club index.
DGI+ Club Index - Drilling Down To Sector Performance
One of the advantages of running my own DGI+ Club index is an ability to readily compare performance of individual sectors within the index. Tables 2.1 and 2.2 below contain similar data to Table 1 and analyze the DGI+ Club index movements by sector.
Over the period since Sep. 28, 2018 (when the share market was considered in bubble territory), Financials have performed the best, and Energy the worst. Since Sep. 30, 2020, Energy has done well, pushing Financials into second place. The main takeaway is the difference in performance between sectors. It raises the question what has driven index performance in each sector. Has it been earnings growth, or has it been multiple expansion. Bear in mind, these 127 stocks are all mature dividend paying companies. There are no pure growth companies which have not yet reached the stage of generating positive earnings. Tables 2.1 and 2.2 show wide variations in returns between sectors. Next I drill down to the ticker level to see if there are similar wide variations between individual tickers within each sector.
DGI+ Club Index - Best And Worst Performers By Sector
Table 3 shows the best and worst performing stocks within each sector within the DGI+ Club 127 stocks index. While the Financials sector, in total, had the largest share price index increase over the 3.25 years Sep. 28, 2018 through Dec. 31, 2021, the largest increase in share price for a single stock was KLA Corporation in the Information technology segment. KLA share price grew at an average yearly rate of 55.8% over the 3.25 years. For the more recent 1.25 years since Sep. 30, 2020, Albermarle stock was the top performer with annualized growth in share price of 116.0%. But the more striking takeaway from Table 3 is the difference between the best and worst performers within each sector. For the 3.25 years to Dec. 31, 2021, Financials sector top performer has 46.4% average yearly share price growth, versus just 1.2% for the worst performer. Similarly for Information Technology, the top performer has 55.8% growth and the worst performer 1.3% growth. This pattern of a wide gap between best and worst is apparent in all sectors. It's not hard to see that two portfolios with similar weighting across sectors could provide very different results depending on individual stock selection. I decided to carry out further analysis to see what might be driving individual stock price high and low performance.
Costco performance compared to Walgreen Boots Alliance
Table 4Table 4 shows Costco Wholesale (COST) share price has grown at an average yearly rate of 32.2% from $228.88 at Sep. 28, 2018 to $567.70 at Dec. 31, 2021. Over the same period, Walgreens Boots Alliance Inc. (WBA) share price has declined at an average yearly rate of (9.8)% from $72.90 to $52.16.
Analysis of change in Costco share price -
Over the period Costco's EPS has grown by 56% from $7.09 to $11.08. In the absence of any change in P/E ratio, the EPS increase would cause Costco's share price to increase from $228.88 to ~$358. The additional increase of ~$210 to $567.70 is due to increase in P/E ratio from ~32 at Sep. 2018 to the current level ~51.
Analysis of change in Walgreens Boots Alliance share price -
Over the period Walgreen's EPS has declined by 19% from $6.20 to $5.03. In the absence of any change in P/E ratio, the EPS decline would cause Walgreens' share price to decrease from $72.90 to ~$59. The additional decrease of ~$7 to $52.16 is due to decrease in P/E ratio from ~12.0 at Sep. 2018 to the current level ~10.6.
High P/E Ratios Driven By Fed Price Signaling
Excerpt from Matthew Zeets, Dec. 17, 2021, article, "Costco: Multiple Expansion Must End Eventually,"
I think it's feasible COST continues to go higher in the short term, as there just aren't that many great places to park money. Bonds don't look good going forward, gold is scary because of Bitcoin, and Bitcoin is scary because of its volatility and relatively short time frame it has been around as an asset class. I believe this lack of safe places to put money is what has driven COST (and many other stocks) up so far in the first place.
Comments by Warren Buffett excerpted from the 2021 Berkshire Hathaway Annual Shareholders Meeting transcript:
I mean, interest rates, basically, are to the value of assets, what gravity is to matter, essentially..., on Thursday, the US treasury sold some four week notes, treasury bills, ...They accepted bids for 43 billion worth. And it says average price. Okay. 100.000000, six zeros. And essentially, people were giving 40 some billion dollars to the registry, and they offered to give 130 billion ... and the treasury received the money at zero...And Janet Yelen has talked a couple of times about the reduced carrying cost of the debt. I think in the last fiscal quarter, US government, which owes a ... few trillion dollars more than a year ago, their interest expense was down eight percent. So you’ve had this incredible reduction in the so-called super risk-free group, the short-term treasury bill, and that is the yardstick against which other values are measured...So you’ve had this incredible change in the valuation of everything that produces money, because the risk-free rate produces, really short enough right now, nothing....if you discounted back and you’re discounting at present interest rates, stocks are very, very cheap...It’s a fascinating time. We’ve never really seen what shoveling money in on the basis that we’re doing it on a fiscal basis, while following a monetary policy of something close to zero interest rates, and it is enormously pleasant. But in economics, there’s one thing always to remember, you can never do one thing, you always have to say, “And then what?” And we are sending out huge sums, I mean, the President said it on Wednesday, 85% of the people, we’re going to get a $1,400 check or… 85%. And a couple of years ago, we were saying 40% of the people never could come up with $400 of cash. So we’ve got 85% of the people getting those sums, and so far, we’ve had no unpleasant consequences from it. I mean, people feel better. The people who got the money feel better, and the people are lending money don’t feel very good, but it causes stocks to go up. It causes business to flourish. It causes an electorate to be happy, and we’ll see if it causes anything else. And if it doesn’t cause anything else, you can count on it, continuing in a very big way. But there are consequences to everything in economics....and they’re doing it in Europe, even more extreme, and they’re pushing, and we’re aiding it with fiscal policy, and people feel good and people will become numb to numbers. Trillions don’t mean anything to anybody, and $1,400 does mean something to them. So we’ll see where it all leads, but Charlie and I consider it the most interesting movie by far we’ve ever seen in terms of economics, don’t we Charlie?
Excerpts from Lyn Alden Schwartzer Dec. 27 article, "What Price Signals Are Telling Us,"
High prices can be painful, but that pain is important to have so that we can respond to it properly as individuals, corporations, and governments.... Price is the single most important signal in markets ... One of the key reasons why a truly-centrally planned economy has never really worked on a large scale is that a room full of guys dictating prices just can’t keep up with the bandwidth...
Summary And Conclusions
The Fed, that room full of guys dictating the price of money, have been putting off decisions on interest rate increases for years. Threats of three rate hikes in 2022, even if they eventuate, will still leave interest rates at historically low levels, and likely already priced into the market. It's difficult to see politicians on either side agreeing on tax increases and/or cuts in spending, so the deficit spending will continue. Warren Buffett is right about trillions not meaning anything to anybody. Lyn Alden Schwartzer is right that high prices can be painful, but that pain is important to have. But at any sign of pain in the share market the Fed has pulled back on proposed interest rate increases. It's difficult to see politicians on either side agreeing on tax increases and/or cuts in spending, so the deficit spending will continue, and is made more affordable by low or zero interest rates. Everybody, excepting lenders, will be happy until a day of reckoning eventually comes. Given the example of Japan, that day of reckoning is likely far, far away. The foregoing means it's likely there remains room for continued multiple expansion over an extended period. Buy and hold has reigned supreme over the last 10 years, and is likely to remain supreme for years to come. Of course, there's always the risk of unexpected change. If change were to come suddenly those stocks with the highest P/E ratios, which have provided outstanding returns, are also the stocks most exposed to multiple contraction.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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