Five for Friday - April 26, 2024

Valuation, Entrepreneurism, Leadership, Geopolitics, and Trade

1. Valuation

While the trend of the stock market has been higher over time, it is an open question what returns might look like over the next 5-, 10-, or 15-year period. Across an intermediate-term time frame, the question of valuation – at what price are you buying stocks – is a fair one to ask (though it is a notoriously bad short-term timing tool). And today, market valuations do look quite expensive compared to history. Take the Cyclically Adjusted Price-to-Earnings (CAPE) ratio, a popular valuation metric which compares the price of the S&P 500 to its inflation-adjusted earnings over the last 10 years. Today, the market is trading at a CAPE of 34x – a historically high reading. Since 1950, the average 10-year forward return from the 30x – 35x range is just 4.2% a year. Even if one could argue that higher valuations are justified for today’s asset-light, high growth, Tech-dominant market, I think it’s reasonable to contend that the returns of the last decade – 13.0% a year! – are unlikely to be repeated (especially if higher interest rates, which tend to put downward pressure on valuations, remain in play). All to say, if a more muted return profile going forward is possible, investors need to prepare accordingly.

2. New Biz

One reason for optimism in the U.S. is that the post-Covid jump in high propensity business applications appears to be a durable trend (a high propensity app is one with an elevated probability of turning into a business with payroll). New business formation is well ahead of the pre-pandemic decade, which is ironic given that those years were characterized by hyper-low interest rates designed explicitly to stimulate activity and capital risk taking. Regardless, innovation is a key driver of economic growth, and that higher rates and inflation have not stifled it is a testament to both the American system and its people’s entrepreneurial spirit. Given that new business applications are also predictive of job growth down the road, it’s just yet another reason to be excited about the U.S. economic story in the 2020s.

3. Leaders

For any market pullback, the key question must be, “is this merely a hiccup amid a broader bull market, or is it the start of something more nefarious?” One useful item in making an educated guess on that front is sector performance; as our partners at Strategas write, “the more important question is what character does leadership assume on any bounce and whether the pro-cyclical tone that has been so dominant for much of the last 6 months can resume?” One pair to watch will be Utilities (defensive, high dividend) vs. Banks (cyclical, economically sensitive). Utilities have been the best performing sector in recent weeks despite higher bond yields (which typically weigh on dividend stocks), but the Banks have also rallied and now sit at a 13-month high relative to the S&P 500. Competing messages, and something to watch.

4. Tensions

In just the last few days, President Biden declared his support for increasing tariffs on some Chinese goods, the House passed legislation requiring Chinese-owned TikTok to divest or be banned, and the U.S. threatened to cut some Chinese banks off from the global financial system if Beijing keeps supplying Russia with military-useful goods. Getting tougher on China is one of the few bipartisan talking points in Washington, and it would not be surprising to see the rhetoric ramp up even further heading into the election. A more multipolar world is leading to a heightened focus on national security over economic efficiency, and the slow fracture of years of globalization will have extensive impact for decades to come.

5. On This Day

In 1956, the world’s first successful container ship, the SS Ideal X, set sail from Port Newark for Houston. In contrast to the sentiment above, the container revolution has been called “the backbone of globalization” for its contribution to the growth in global trade (seaborne transport accounted for over 70% of the total value of trade as of 2019). In recent years, freight rates have come into focus for their huge impact on inflation when key routes are disrupted (Covid-19, Red Sea attacks, etc.). A more multipolar world may be forming, but global maritime trade remains as critical as ever.

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This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy.

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