Wednesday, January 3, 2018

"Yes, Virginia, there is a Santa Claus" - Francis Church, September 21, 1897

From the Desk of Joe Rollins

You are probably wondering why I selected the title above for my year-end blog. I have heard it my entire life, but I never quite found the opportunity to use it in a financial blog. Now I can. Two days before Christmas, our current president, Donald Trump, signed into law one of the most sweeping and, potentially, the most beneficial tax changes in the history of American finance.

In the following commentary, I will hopefully be able to explain to you exactly how the economic benefits that flow from this tax change will affect all of our financial lives going forward. This is a really big deal! Also, I want to reflect on the fact that in 2017 the S&P 500 index had basically a perfect record. This was the first time ever in the history of American finance that the market was up every single month, having no negative months for all of 2017. This is a record that is unparalleled in American investing. You are probably wondering, "How did this happen?"

It might be that we are beginning to witness the start of a few financial golden years in the United States. No longer will corporations be required to relocate outside the United States due to lower tax rates. In fact, they will rush to manufacture in the United States due to the excellent business environment here. In addition, we never believed that we might accomplish energy independence. However, due to technology and the innovation of the oil industry, we are no longer dependent on Middle East oil in the case of a crisis. We have full employment in the United States, interest rates are at historic lows, corporate America is generating more profits than ever and its economy is getting stronger by the day. This might just be a recipe for a few golden years in the U.S.

Ava as flower girl in Carly and Erik's wedding

Crown of Statue of Liberty, November 2017

Snow in Atlanta?!

Before I can get to all of those very important subjects, I need to give you the year-end financial results, which were excellent.

Needless to say, the scorecard for the year 2017 was nothing short of spectacular. As I reflect back on the year, although I had projected a nice increase in the beginning of 2017, I wasn’t even so optimistic as to see this level of returns. For the year 2017, the Standard & Poor’s 500 index was up a sterling 21.8% and has averaged a 5-year return of 15.8%. The NASDQ composite was up 29.7% for 2017 and the 5-year average has been 19.4%. The Dow Jones Industrial average was up 28.1% and has averaged 16.4% over the previous 5-years. Just for a basis of comparison, the Barclay’s aggregate bond index was up 3.3% for 2017 and has averaged 1.9%. It is clear that bonds have not even come close to keeping up with equity investments for the last five years.

The month of December was somewhat odd in that growth actually trailed value investments during the month. The international funds continued to be strong and the bond funds returned almost nothing. While it was a relatively subdued market in December, it ended as one of the most productive markets of all time. If you know anything about the markets, you know that you must be invested when we have excellent years. I have never understood why there is so much money sitting in cash earning exactly zero during these very profitable investing years. Are you one of these investors?

This is what happens in corporate America when you decrease the corporate tax rates from basically 35% to 21%. You can see the positive benefits that this tax cut will have on future earnings. As I have reported so many times in my personal blogs, earnings are by far the most important component of the stock market valuation. After the signing of the new tax bill on the Friday before Christmas, corporate America has been overwhelmingly expressing their satisfaction. This was done in the form of many corporations giving bonuses and salary increases to their employees. Companies were falling all over themselves to explain how they were going to use this tax reduction to benefit America. That, my friend, was exactly the intent of the new administration.

I read so many publications and newsletters that I oftentimes forget exactly where I have read a quote. Many indicate that the approval rating on this tax decrease by Americans was only 30%. Presumption being that 30% of the U.S. population agreed with the tax decrease so therefore 70% either disagreed with it or had no opinion on the subject. But frankly Virginia, if you do not agree with the tax cut then you do not understand Economics 101.

The reason the stock market has been so good in 2017 is very simple. Economics has benefited corporate America and their earnings have gone up. Ever since the election of the new president, the administration has dramatically reduced regulations throughout corporate America. In addition, the economy has greatly improved resulting in higher earnings. Higher earnings support the stock market going higher and as it did in every single month in 2017. Stock market performance is a direct result of higher earnings.

You need to understand basic economics to understand the effects of the tax cut on corporate America. There are so many publications and negative articles written due to the fact that they do not understand how corporate America records their tax provisions. I read the negative reports that say that the average American corporation only pays a tax rate of 21% and therefore this tax decrease will not benefit them. They may have in fact only paid 21%, but they are required to record on their books at the highest statutory rate north of 30%. A 5% return to a company’s bottom line under the old rules will now generate a return of 15% to their bottom line under the new rules. These amounts will be nothing short of staggering and beneficial to these corporations and, therefore, America.

In addition to the wonderful benefits of the corporate tax rates, virtually everyone will receive a reduced tax rate. I recognize that it is impossible to reduce the tax rate of someone who pays no tax, and therefore that argument is completely moot as far as I am concerned. However, when you decrease tax rates among the broad population you will benefit all Americans. Almost universally, this money will be spent creating higher commerce which will create jobs. Jobs create economic activity and therefore a higher standard of living for the general population.

While questionably the deficit is on everyone’s mind as we go forward, I have reviewed the projections and have a high-level of optimism that in fact the deficits may not be nearly as high as projected. If you want to get a real feeling for the plan, you have to understand the difference in economics under the old administration and the new administration. For the 8 years in the previous administration, the GDP averaged 2.1%. Interestingly most of the bad quarters were late in the presidential cycle, not early. This was the lowest GDP growth realized over an 8-year period in America since WWII.

The new administration took office in 2017, and every quarter a GDP growth of 3% or higher has been realized. In fact, going into 2018, the GDP growth is forecasted above 3% in virtually every quarter. If, by chance, these tax decreases could increase economic activity by only 0.5% per year, there is a high likelihood that over the next 10 years, in regards to our $1.5 trillion deficit, these tax cuts could essentially pay for themselves. If you believe that these tax cuts will result in corporate America creating more jobs, paying more dividends or buying back more stock to create value to the average investor then you can certainly see the economic growth increasing significantly going forward. All as a result of the tax cuts.

I also read many articles that take the position that money repatriated from overseas to the U.S. and then spent to pay dividends or to buy back stock is not beneficial. I am just not sure what planet people making that exclamation live on. If money that is sitting idly earning virtually nothing overseas is brought back to the United States with a 15% tax rate, and then the corresponding corporation uses that money wholly to pay dividends and buy back stock, every single leg of that transaction creates income tax to the U.S. government. How anyone under any definition could see that as a negative defies economic reality and basic common sense.

The most interesting financial result is that for the first year in a very long time we are witnessing a world-wide boom in economic activity. The entire world appears to be on the upswing. There is also a high likelihood that during 2018, inflation will pick up which will dramatically increase the value of commodities. This increase in commodities will be a huge boom to the emerging markets that depend upon oil for their wealth. So not only do I expect to see the U.S. economy strong, averaging a GDP of roughly 3.5% for 2018, I expect to see the rest of the world’s economies pick up which will improve the sales of U.S. corporations in all countries around the world. If you review the projection I made at the beginning of this year, I assumed that the S&P 500 would be up 10% in the year 2017. I may have been one of the few forecasters that would even venture a number as high as double digits at the beginning of the year. Fortunately, I was very wrong and the S&P ended up 21.8% - more than double my projection. However, from a strictly arithmetic standpoint, my projection was not very far off. The difference in the projection and the actual was that I projected a multiple of 17.5 times projected earnings in 2017. In fact, the multiple ended up being just north of 20 times and therefore the error in calculation

While you may think a 20 multiple on earnings is excessive given the potential growth of earnings and the expansion of the economy, and interest rates being low for most of 2018, it is not a reach to come to that conclusion. Therefore, my projection for 2018 is based on simple arithmetic. The Standard & Poor’s company has projected earnings of $145 per share on the S&P 500. This projection was not based upon the new tax rates that are currently in existence. Therefore, my estimate is that corporate earnings will go up 17% and, therefore, $169 per share.

In last year’s projection I made an assumption that earnings would grow between a multiple of 17 to 18 and I elected to pick the halfway mark of 17.5. Currently, earnings are at 20 times, but historically that is too high. Using a high but reasonable multiple, given the increase in earnings, I would use an 18 multiple which would project the year-end S&P at 3,042. Using some sort of geopolitical event that might reduce earnings during the year, I will round down to exactly 3,000 since everyone likes rounded numbers. Therefore, the increase in earnings from today’s valuation at 2,673 to exactly 3,000 would mean that the S&P would go up $327 or roughly 12% for the year. To that you would add the dividend ratio of the S&P 500 at roughly 2% for a total of 14%. Therefore, my projection for the S&P 500 going forward for 2018 would be somewhere between 12% and 14%, so for the sake of averages, let’s say a 13% growth for all of 2018.

Yes, it is true I was wrong about 2017 and I hope I am wrong about 2018 in a good way as well. I would much prefer that the return on 2018 be much higher than 13%. However, any high single-digit or low double-digit number would be a welcomed result, after the sterling results we had for 2017. It has been nothing short of a spectacular financial year, and I have nothing but encouraging thoughts going forward. If the tax cut does as I project and the administration continues to keep the government out of business’s way, it could lead to a world-wide economic boom that lasts for 4 to 5 years. We all are hoping so!

As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins

Tuesday, January 2, 2018

14 out of 15 is not bad; it is great!

From the Desk of Joe Rollins

Every year, I try to give you a scorecard on how the stock market is doing from an investment standpoint. Based on the chart below, the Standard and Poor’s index of 500 stocks has now been up 14 out of the last 15 years. Every day, I am confronted by cynics in the stock market that just cannot believe that the market is real and goes up every year. However, the chart below absolutely proves without exception that if you intend to retire on an income similar to the one you earned during your working years, you must be invested in assets that appreciate like the stock market. As reflected in the chart below, if you had invested $10,000 on January 1, 2003, at the end of December 31, 2017, your investment would be worth $41,309. You do not have to be a rocket scientist to calculate that your original investment of $10,000 was up a cool 313%.

Over and over again, I meet with potential clients who sold all of their investments in 2008 and never reinvested. Their reasons for not reinvesting vary, but almost none of them reflect economic reality. Basically, this chart says that if you had invested in the S&P 500 Index in 2003 and had done nothing whatsoever with your investments, including during the 2008 correction, you would be 313% better for having done so.

I doubt there is a clearer advertisement for investing going forward than the chart above. We are not even talking about actively managed investments here; this is just a passive index of the 500 largest corporations in America. It does not include international investing or even emerging markets, which has the potential in 2018 to be a very strong performer. My goal for sharing this chart is to provide you with information that will allow you to evaluate your investments going forward.

I am sure that you are anxious to hear my year-end evaluation of the stock market and my projections for 2018 but, unfortunately, you will have to wait another 24 hours to read all about it. In the meantime, if you have any questions regarding the numbers reflected in the chart above, please let me know.

As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins