Dear Clients and Friends of Insight,
Those of you who have been long-time readers of Insight’s letters know that we have held steadfast with our positive view toward the U.S. stock market and the rewards of stock ownership, generally. This view has been based on our strong belief in the underlying strength and resiliency of the U.S. economic system and its powerful influence on the global economy. Over these years, investors have endured a string of serious challenges which have threatened them with the potential loss of capital. The European debt crisis, a collapse in oil prices, the “flash crash”, escalating global trade wars, and our current pandemic, come to mind. Thus far, stock owners with a disciplined, long-term focus have been more than adequately compensated for the risks they faced. Our clients, who now have large capital gains, are happily among them!
Today, uncertainties loom large, risks have multiplied, and inflation is a threatening danger. We expect to experience some challenging stock market periods ahead and we are more cautious in response. To be clear, though, we maintain our positive long-termview of selective stock ownership. Let’s review why.
Stock prices are a function of the varied combination of three factors: fundamental business results, investor sentiment, and stock valuations. Starting with fundamentals, most business results have been incredibly positive, and many companies have booked explosive growth in sales and earnings. This growth is a significant factor which fueled stocks to all-time highs this summer. Of course, these unprecedented results are not sustainable and year-over-year comparisons have likely peaked, adding confusion to the outlook.
Investors focus primarily on the future and they know future profit margins are under considerable pressure. Costs for materials, energy, transportation and labor have all increased, and they will likely go even higher. As well, the need to invest larger amounts of capital to navigate the current challenges from supply change disruptions and technology shifts could be significant. Throw potentially higher taxes into the mix and earnings prospects look even more challenging. The primary driver for continued corporate profit growth will need to be improved productivity – and it must improve enough to sufficiently offset these current and potentially lingering headwinds. We expect these productivity improvements to be attainable for many companies. More on this subject in future letters.
Moving on to investor sentiment, it has been mixed as many economic results are softening due to the responses to increased Covid-19 uncertainties. Investors know that the monetary and fiscal policy commitments have been, at a minimum, a backstop to these risks. “Don’t fight the Fed” has always been good advice for investors, and the Federal Reserve Board continues to indicate its intent to safeguard investors from these risks. Yet, investors know that these stimulative policies are also not sustainable and threaten to hinder longer-term economic outcomes. They also realize that the global economy is far from performing at full capacity, discovery and innovation are materially improving global standards of living and the human condition, and investment capital is abundant and enthusiastically available to invest in a wide range of these opportunities. Throw into this mix that the expected return from bonds and other conservative investments is meager, and well below current inflation rates across much of the globe. And, investors face even higher risks committing capital to less traditional investments such as real estate, commodities, precious metals, and emerging markets. Combined, U.S. stocks continue to appeal to global investors.
This leads us to the market’s valuation which is currently very high. The price-earnings ratio (P/E) for the S&P 500 is about 23x and should indicate caution. This valuation is considerably higher than the pre-pandemic years when P/E levels were generally within their historic band of between 15x – 20x. This tells us that investors are still expecting (or hoping for) strong growth to continue for the economy and corporate earnings, and especially for many of today’s most popular stocks. Any disappointing reports, which will likely occur, will surely hurt their stock prices. Fortunately, expectations for many companies are reasonable and their stock prices are as well.
We look forward to discussing with you these important risks and opportunities over the coming months, and sharing our counsel with you on their implications for your portfolio in the context of your personal circumstances. Please don’t hesitate to call us with your questions or concerns, which could surely arise. In the meantime, we will continue to prudently rebalance portfolios while keeping each client’s risk tolerance and capital gains considerations front of mind.
For those of you interested in understanding more about our investment decisions and our counsel to clients during this very unique investing environment, we encourage you to visit our website at www.insightinv.com. We have recently added our last five years of letters for your review and consideration.
INSIGHT INVESTMENT COUNSEL