The first non-textbook on investing I ever read was One Up on Wall Street by Peter Lynch. In it, the former Fidelity fund manager detailed his homespun rules of investing. One I remember, and follow to this day, is that when people line up to enter a store and the merchandise is at full price, versus on sale, it usually augers well for the retailer. As a father of three, I more than seldom find myself in shopping malls, and as a habit, walk in and out of retailers to put the discipline to the test. Even with the growth of online sales, the boots-on-the-ground research is often spot on.
In 2008 and 2009, business activity was reeling from the recession. Restaurants were half full at lunch and dinner, and airports were sparse. Now that many of the large airlines have had their debts forgiven and merged with other carriers, ticket prices are higher than ever and service at its low-point. Since that time, global equities have returned about 20% per year, twice the long-term average.
A few weeks ago I took my teenage daughter, Lily, on a trip to Italy. 45 minutes outside of Florence is a designer outlet mall, in which the highest fashion brands have elegant stores with this season’s new wares. The mall was full of tourists, mostly from Asia and Russia, who arrived in cars and buses to shop for Milan-designed pocketbooks, clothes, shoes and accessories. Some of the stores queued the shoppers to control store traffic.
On my last trip to Slovakia, I noticed that Business Class was full, as were the airport lounges in Austria and Germany, the restaurants and bars. In Paris, velvet ropes made the stores in the Galleries Lafayette seem like nightclubs and in London, businessmen packed the Wolseley until 10:30 a.m.
These observations are all to say that in the developed world, business is booming, and people from the entire world, including the emerging markets are spending capital on luxury goods, whether real estate in Manhattan or London, or Prada bags in Florence.
Given how low global interest rates and inflation are, the fact that there are more consumers who are spending on goods, services and travel is a bullish sign for the equity markets. In addition to the fact that companies can grow their profits with inexpensive cost of capital, investors are living longer (needing more growth in their portfolios), companies are buying back their shares (boosting stock prices and earnings per share) or finding companies with which to merge (thus sucking the supply of stock from the market).
So, the question on many people’s minds is “When does the bull market end?” Usually bull markets end when the market goes up on bad economic and corporate news. That is a signal that the majority of investors are bullish, believing the market cannot go down. That is not the case today. The market is split between bulls and bears, according to most surveys.
Bear markets also tend to start when valuations are excessive. The price to earnings ratio of the broad market is often cited, and today it is elevated but not excessive.
In addition, companies discount their future earnings stream by their cost of capital, which in turn is influenced by interest rates generally, credit spreads and inflation. These latter elements are quite low today, and firms have more financial flexibility (cash) than ever before, cautious about embarking on a hiring spree for fear of the next downturn. This means corporations can withstand shocks and engineer profit growth amid the economic recovery.
Despite my observations on global commerce, the recovery itself is muted but consistently positive. Economists postulated that the reason the US GDP showed contraction in the First Quarter of 2014 was due to the Polar Vortex – an unseasonably cold winter across parts of the globe. If ice and snow can keep folks from getting higher wages and buying homes (labor and housing are the driving forces in the US economy), then we are probably far from having inflation and high interest rates spoil the stock market rally.
Investing is both art and science. We consider qualitative and quantitative factors of each solution in sync with the investor’s needs for liquidity, income, safety and growth. However, the degree to which we emphasize any particular asset class or investment is heavily influenced by our future outlook. We look for direction from current economic readings, but often, like in the case of the contraction in First Quarter 2014 GDP, contrasted with over 200,000 new non-farm jobs created in each of the first five months of 2014, the data is contradictory. It is then that boots-on-the-ground scent-smelling helps us better read the signs.