When Does the Party End?
Board: Supernova Phoenix 1
[This post is from our premium service Motley Fool Supernova. Click here to take a no-risk free thirty-day trial of any of our services.]
Thanks for asking these questions. I think they are on the minds of a lot of investors these days. I'm going to give you some very general comments that are going to sound a little like the "company line" but first I'll try to respond a bit to your specific concerns, since I think you are sincerely looking for some answers.
I'm no expert in economics, so take this for what it's worth. But I do think these issues are well known and there are counter arguments for them.
Earnings as a % of sales for S&P is near 9%, highest it's been in 20 years. Unlikely to go higher.
Companies are unlikely to be able to boost margins further due to very weak capital investments for the last 4 years.
I've heard this argument a lot. Profit margins are high, so they will regress to the mean. But there's really no logical reason why that has to happen, and especially no reason to think it will happen soon, in my opinion. Companies have gotten much leaner in a time of low economic activity, so as sales pick up (which they are, only more slowly than people would like), operating leverage will cause margins to continue to improve. What could eventually cause this to reverse is wage/price inflation, which, as you point out, is nowhere on the horizon at the moment. When it *does* appear on the horizon, it could very well be in a context of a more rapidly economic expansion, which will help top lines. That is not necessarily a bearish scenario for stocks.
The capital investment argument is contradictory, I think. If margin improvements have happened in a context of low capital investment, what's to say that can't continue? And if capital investment starts improving, wouldn't that be better for margins, not worse?
Employees have not been as "cheap" as they are now over the last 60 years. Total compensation equals about 54.6% GDP.
Sad for the workforce, good for business, good for stocks. Sure it could reverse, but same argument as before: rising wages could be accompanied by an economic boom, which could balance out the effects of higher wage costs.
Wages are rising much faster in China and other overseas markets than in the US.
Management has learned that world spanning supply chains almost always harbor unforeseen costs, off-shoring is not the no-brainer it once was.
These facts are causing what I believe is the beginning of a renaissance in American manufacturing, an awesomely good thing in my opinion. I worked in a business where I started seeing this happen two years ago and more. Are rising Chinese labor rates hurting businesses? See earlier comments about record profit margins in spite of this. Our incredibly adaptive capitalistic system will respond as businesses optimize their supply chains to source materials and labor closer to customers (a growing number of which are in China, actually.) The information technology tools to make this happen have never been so advanced. New factories in North America will be more efficient than ever. By a lot. And sources of energy here at home are getting cheaper, driven by new abundance of natural gas, which is also a feedstock for plastics and chemicals going into the products being manufactured.
The upshot is that the only way earning can continue to grow is for sales to continue to grow.
I just think this is untrue. But...sales WILL grow, unless we have another downturn. This is happening now, just more slowly than people want.
The article did say there was some faint hope for improving economies, but I think not much.
Well, apparently reversion to the mean happens to profit margins but not economic growth -- do you buy that? Profit margins are higher than historic averages, so they must decline; economic growth is lower than average, so it must stay that way forever. Hmm.
Our economy remains anemic. Europe is in even worse shape. China's recovery is slow and questionable (can you trust the reported economic data?). And there simply aren't any other markets big enough to make much of a difference. Japan? Come-on, get serious.
So...might this portend better days ahead? Might slow economies speed up? Regarding China, I recommend you just focus on results that our companies who are selling into China are seeing. Growth in China sales in undeniable, and who cares about China government statistics when what counts is that people are buying "our" stuff? And...Japan...their stock market is up 70% in 6 months. Check this out:
There is a reason for this: a new government that has reversed the deflationary, strong yen policies followed for many, many years.
So those are some specific rebuttals to the issues worrying you. I'm not an expert and I could be wrong, but please realize there is another side to these issues. Now here are my "company line" generalities --
* There are ALWAYS worries like these. I'm retired, living off my investments, and have invested in individual stocks for over 40 years. All these worries are nothing new -- just the details change. Remember double-digit inflation, double-digit unemployment, and double-digit interest rates, all at the same time? Within a couple years, the greatest bull market in history started and lasted 18 years.
* Trying to protect yourself against market declines is mostly futile and usually just reduces your portfolio performance. The best protection is to make sure that you keep an adequate amount of money out of the market to enable you to ride out declines and still sleep at night.
Let's say the market DOES decline by 20%, in a single day...tomorrow. That would take the S&P down to 1327, a level that it closed below on June 26, 2012. That's less than a year ago. So one way of looking at it is that even a major correction would only cause you to lose less than one year of portfolio performance. You'd be back to where you were last summer. Were you this worried about your future back then? You'd be no worse off now.
It could happen. Many of us remember October, 1987 when the market crashed 30% in a few days. Take your portfolio and multiply by 0.7 to see how you would feel. The macro situation looked good in those later Reagan years, the market had been doing great, and then, Boom! I remember looking at my portfolio and realizing it had just regressed to about the point where it had been a year or two previously. With hopefully 40 or 50 years of life ahead of me, how big a deal was that? Despite the wailing and gnashing of teeth going on, I did...nothing. The market recovered in under two years.
Had I tried to protect myself from this event -- which in the long run had ZERO impact on my financial future -- I might have missed out on much of the returns of that incredible market.
So here's where my comments sound like I'm just giving the "company line." My plan is pretty much the same now as it was then. I'm 59, so I need to assume I could live another 30 years. So I need equities, and I need a long term view. I just need to make sure I have enough money outside the market to be able to shrug off the disasters, which virtually never happen when you think they're going to happen. Now that I'm retired, that's more money than it used to be, but for that money that's in the market, the plan doesn't really change.