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Markets within Markets: Assessing the High Levels of Dispersion in Stock Valuations

Markets within Markets: Assessing the High Levels of Dispersion in Stock Valuations

Is the market cheap or expensive? This simple question is a constant source of debate among investors, who search endlessly for clues to support their bullish or bearish views. With stock prices hovering around all-time highs, and common valuations ratios for the S&P 500 index at levels not seen since 2008, I would be somewhat hard-pressed trying to make the case that stocks are historically cheap. That said, growth prospects in the economy can, in theory at least, justify just about any valuation level. 

One significant challenge in assessing today’s markets is the very high level of dispersion in stock valuations. While the market overall may look pricey, the picture gets murkier if we look under the hood to consider individual market components. Increasingly, different sectors that compose some of the main stock indices are behaving like totally different markets, and while that is always the case to some extent, the current level of disparity hasn’t been seen in decades. 

In its recent quarterly market report, JP Morgan provides some great data to illustrate the current situation. Since 1996, the level of valuation dispersion (defined as the difference between the 20th and 80th percentile) for stock valuations in the S&P 500 has been 11.0 on average; today the current valuation spread is 19.7. As shown below, the spread is the highest it’s been since 1996, and you’d need to go back over 20 years, to the early 2000s, to find comparable dispersion.

In practice, it means that in today’s world, a sector like consumer discretionary (which includes Amazon and Tesla), is more than twice as expensive as some of the cheaper sectors, like financial services or energy.

The theme of valuation spread yields equally striking results when considered from a different angle: country and regional valuations across the world, rather than between U.S. sectors. As shown in the chart below, the valuation spread between the most expensive region (the U.S.) and the cheapest (emerging markets) is currently at levels not seen since, once again, the early 2000’s.

What should investors make of this increasingly disparate world? Investing would be much easier if we only had to look for cheap valuations to infer future returns, but in fact, cheap stocks may turn out to be value traps. Valuation metrics such as Price to Earnings ratios (PE) are meaningless in isolation, and must always be interpreted in the context of a company’s growth prospects. In other words, high valuation levels aren’t necessarily “expensive”, and low valuations aren’t necessarily “cheap,” just like an inexpensive used car isn’t always a good deal. 

In recent years, buying the most expensive stocks has been the winning strategy, as they continuously grew into higher and higher valuations. Every trend eventually comes to an end, and extreme positioning could be an early sign of a potential reversal. The early 2000s were, in hindsight, a transition period between the roaring 1990s and the lost decade of the 2000s. Eventually, paying an ever-growing premium for trendy stocks will leave investors chasing increasingly unrealistic growth targets. In the context of a well-diversified portfolio, it might be time to take a closer look at today’s unloved stocks, with a bit of luck, we might just find a good deal.

Syl Michelin, CFA®

The Case for Using Dividend-Paying Stock in a Yield-Starved Market

The Case for Using Dividend-Paying Stock in a Yield-Starved Market

As we look to the second half of 2021 and take an assessment of the markets one year after the post-pandemic recovery began, it’s frankly difficult to feel anything but extremely relieved and grateful that global markets faithfully marched onward through human tragedy, political turmoil, and the Aaron Rodgers pseudo-holdout that followed a second straight defeat in the NFC title game. Clearly, the market has been more like Tom Brady than Kirk Cousins, continuing to win even though the run has left both Brady and the U.S. stock market’s bull run a bit long in the tooth, but still hard to bet against.

However, as we turn the page on the first half of 2021 and look ahead to 2022, it’s hard to ignore valuations and worry that, like the Minnesota Vikings, money put to work here and now may give us a Kirk Cousins-like vibe sooner rather than later, meaning that we run the risk of overpaying for expectations that may be beyond our grasp or control. In short, valuations matter, and we shouldn’t give stocks or our quarterback a blank check.

But the core issue facing investors should rarely, if ever, be whether to invest, but where to continue to invest, or how to properly allocate their investments. That seems even more important than ever when we look at the following relative performance metrics over the past 12 months (August through July), based on the total return of popular ETFs tracking the following indexes:

%

S&P 500

%

NASDAQ 100

%

Russell 2000

%

MSCI EAFE (Developed Markets ex: US)

%

MSCI Emerging Markets

%

Barclays Aggregate U.S. Bond Index

That’s an impressive throttling by all major stock markets versus the bond market! Looking closer, and perhaps not surprisingly, the relative return of various stock markets appear to be inversely related to the dividend yield generated by each respective index. Here is an approximate 12-month trailing yield for each of the ETFs upon which these stock index returns were calculated:

%

S&P 500

%

NASDAQ 100

%

Russell 2000

%

MSCI EAFE

%

MSCI Emerging Markets

I would argue that interest rates played more than a minor role in the relationship between valuations, dividend yields, and the outperformance of high-valuation/low-dividend-paying (or we could use the oversimplified term “growth”) versus the lower-valuation/higher-dividend-paying (“value”) stocks over the past year (and going back over the past several years going back to the Great Recession). When interest rates are abnormally low, the “valuation” of the distant future earnings promised by younger, fast-growing companies is distorted by an abnormally low “discounting” of the future earnings, because the discounting is based on prevailing interest rates. Thus, lower interest rates result in a higher present value calculated for companies that promise massive earnings in the more distant future. 

So what happens should interest rates rise, or even rise dramatically? That would tend to have a more negative effect on the valuations of companies with future projected earnings streams that are more back-end-loaded (meaning the bulk of the future earnings are still several years out from today). We’ve seen this play out in the Russell 2000 and the Nasdaq on trading days when interest rates climb on robust economic data (e.g., a strong employment report), often resulting in considerable rotation out of the growth stocks and into “safer,” or “blue chip” stocks that have lower valuations and, quite often, pay dividends out of the company earnings on a regular basis.

Therefore, while rising interest rates are a substantial risk to bond holdings and, arguably, growth stocks that have dramatically outperformed in recent years, the allure of dividend-paying stocks appears rational from both a risk management and a valuation perspective going forward. This volatility (risk management) and return proposition have always been true, but relative underperformance of dividend payers in recent years may increase the odds that dividend payers will enjoy a more profound comparative risk/return profile going forward.

A study by Ned Davis Research and Hartford Funds compared the relative average annual returns and volatility (measured by the standard deviation of returns) of dividend payers in the S&P 500 versus those companies in the S&P 500 that did not pay a dividend. The study examined return data over a very long period: March 31, 1972, to December 31, 2019. It was discovered the dividend payers enjoyed average annual total returns of 12.9%, which was a dramatic outperformance compared to the average annual total return of 8.6% by S&P 500 component companies that did not pay dividends. The relative volatility characteristics of the dividend payers versus the non-dividend payers were equally profound. The average standard deviation over the study period for the dividend-paying component companies of the S&P 500 averaged 15.6% versus a staggering 24.3% average standard deviation for the non-dividend-paying component companies! The upshot is undeniable: Dividend-paying stocks provided both superior returns and lower risk for their investors, a proverbial best of both worlds.

We also want to share some additional points for those investors who want to harvest some (if not all) of the income from their portfolios: Where else but dividend-paying stocks are you going to find yield today, tomorrow and in the years to come? While the potential for rising bond yields in the future increases the potential that bonds may one day again provide a meaningful income stream for investors, this would very much come at the expense of bonds that have already been issued. In other words, bonds carry interest rate risk, and the further out the maturity for the bond, the higher the interest rate risk. Moreover, bonds also carry substantial inflation risk, meaning that the risk that rising prices will reduce the value of the interest stream (coupons) paid by bonds and also the purchasing power of the principal that is promised to the investor when the bond matures. While stocks, even dividend-paying stocks, carry some interest rate risk and also inflation risk, stocks and particularly dividend-paying stocks have distinct advantages. For one, companies can, to varying extents, pass rising costs of doing business on to their customers. Similarly, dividend-paying companies can increase their dividends over time, while most bonds pay fixed sums of regular interest.

Accordingly, for years, the global stock markets have risen in part on their relative attractiveness compared to bonds in a low-interest-rate environment. These stock markets might continue to do so in a rising interest rate environment, and/or in an inflationary environment. However, not all stocks are equally up to the challenges of rising rates and inflation. Those companies with relatively higher current earnings power and those companies that can increase their income payouts to shareholders should be better positioned to weather either, or both, storms and, therefore, we believe that they can play a very important role in investors’ portfolios going forward.

Stan Farmer, CFP®, J.D. 

DISCLOSURES
Walkner Condon Financial Advisors is a registered investment advisor with the SEC and the opinions expressed by Walkner Condon Financial Advisors and its advisors in this article are their own. All statements and opinions expressed are based upon information considered reliable although it should not be relied upon as such. Any statements or opinions are subject to change without notice.

Information presented in this article is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed.  

Information in this article does not take into account your specific situation or objectives and is not intended as recommendations appropriate for any individual. Readers are encouraged to seek advice from a qualified tax, legal, or investment advisor to determine whether any information presented may be suitable for their specific situation. Past performance is not indicative of future performance.

Financial Check List for the End of the Year

Financial Check List for the End of the Year

There is a small, but distinct, satisfaction that comes from crossing items off of a list. The immediate sense of accomplishment gives us a boost that propels us to the next thing on the list. Whether it is a chore list on the weekend or items off a grocery list, we, as a whole, increase our productivity when we have a set of priorities. 

Our financial lives would benefit from a task list just the same. As we move through 2021 with Covid still in the news and the stock market enjoying another great year, we should keep in mind that there are still things to accomplish pertaining to our finances. Think of this as a mid-year financial checklist: 

1: Fund your IRA, HSA accounts

If you have personal retirement accounts, such as Roth or Traditional IRAs, be aware of how much you have contributed to this point and how much you plan to fund before April 15, 2022. The maximum contribution amount for Roth or Traditional IRAs for 2021 is $6,000, or $7,000 if you are over the age of 50. Monthly systematic contributions plans are a great way to fund these accounts; however, many of these plans were set up years ago when the contribution limits were lower. You may not be max funding your account if you haven’t increased your monthly amount within the last few years. Health Savings Accounts are another great way to save money in a tax-preferred way. Not everyone is eligible for an HSA, so check to make sure you qualify. The 2021 contribution limit for individual HSA accounts is $3,600 and $7,200 for family accounts. 

2: Complete your RMDs from IRA, Beneficiary RMD

Required minimum distributions, or RMDs, are annual distributions from IRA accounts. In 2020, required minimum distributions were suspended and have been reinstated for 2021. Recent legislation has increased the age for RMDs to 72 for tax-deferred IRA; however, inherited IRA accounts have different distribution restrictions, so be aware if you are the owner of an inherited IRA as you may need to take distributions prior to age 72. RMD’s must be taken by December 31 of each year, except in the year that you turn 72, in which you have until April 1 of the following year. It is the responsibility of the IRA owner to ensure that the total RMD amount due is withdrawn each year and that the calculation takes into consideration all of their tax-deferred IRA assets.  

3: Verify your 401k, 403b Contributions

The maximum amount that employees can contribute to their 401k or 403b accounts for 2021 is $19,500, with an additional $6,500 allowed if the employee is over the age of 50. This maximum contribution amount has been increasing over the last few years so it is important to verify the amount coming out of each paycheck if your desire is to max fund your account. These limits do not take into consideration any match provided by your employer. Most employers offer flexibility in making and changing contribution amounts, so you could increase your amount mid-year if you are not on track. Also, be aware that many of the 401k or 403b plans now offer a Roth option within their plan. This doesn’t affect any Roth IRA contributions. 

4: Check Your Mortgage Rate For Possible Refinance Opportunities

I fully realize that the mortgage refinance discussion is becoming quite repetitive at this point, but it does bear repeating. The current mortgage rates are under 3% for a 30-year fixed mortgage, and the 15-year mortgage rate is in the low 2% range at many lending institutions. We generally advise looking into a mortgage refinance if you are planning on staying in the home for at least 3-5 more years and a rate reduction of at least .5%-.75%. That said, everyone has a different financial situation and should consult with a financial advisor or mortgage specialist prior to making a final decision. For many people who have refinanced within the last few years, another refinance may not be appealing; however, it would behoove you to look into this option again if the variables are in your favor. 

5: Review Your Cash Position, Travel Expenditures

Take time to review your current cash position and the amount of cash you prefer to have at any given time. A person or family’s cash position is an interesting subject within the world of financial advising. We have clients who need six-figure cash positions to feel comfortable, while other clients desire to hold small cash positions as they don’t like “money on the sidelines.” We like to frame this conversation by taking into consideration any other investment and retirement accounts. For example, a client with a large taxable account can afford to get away with a smaller cash position in contrast to a client with all of their non-cash assets in IRA or 401k accounts, where liquidity provisions are more onerous. We strongly believe that every well-built financial plan has a healthy cash position to cover job losses, emergency expenses or unexpected travel. The current low-rate environment is creating a challenge to find a decent return for cash; however, safety is the main job for this portion of your financial plan. 

This is not a comprehensive list, by any means, but I hope this makes you think about a few things to review between now and the end of the year. We are more than happy to discuss any of these items with you and how they pertain to your overall financial plan.

Nate Condon

Three Tips For Improving and Organizing Your Email Experience

Three Tips For Improving and Organizing Your Email Experience

As I was sitting down to write, my intention was to go through growth versus value investing. While still an important topic – one I touched on in this video – I instead chose to write about something non-financial that has impacted my life recently, something that warrants sharing. 

At the time of writing this, masks are getting put back on as the Delta variant takes hold, and potentially, lockdowns could be back on the table. All of this can certainly cause stress, especially as COVID-19 lingers on longer and stronger than many anticipated.

Doing something that allows you control – and also the ability to declutter – can be helpful to reduce stress and put you in a better mindset. In fact, there’s quite a bit of internet literature that discusses the benefits tidying up can have on mental well-being. And decluttering doesn’t just apply to our homes or apartments; it’s just as, if not more, important for our digital environments. So, I chose to focus on organizing my digital life, namely my email. If you’re like me and are (somewhat?) neurotic about keeping a clean inbox, here are a few things I did to better organize my email:

Create Filters to Organize your Email More Efficiently 

Do you have some emails that come to you every day that you don’t want to remove but you want to mark them as read or archive them? Most mail programs can do this, but I use Gmail myself and will show examples from that email provider. If you go to your “settings” and then “filters”, you can create a filter that takes emails and does something with them. 

For example: 

Matches: from:([email protected]); Do this: Mark as read

I have an automated email that sends me five separate emails a day for each of my portfolios, so this is helpful to keep unread emails from piling up. If we take this one step further, I have also created labels that will automatically categorize and group certain emails. 

For example: Matches: from:([email protected]) Do this: Mark as read, Apply label “IBKR Notices”, Categorize as Updates.

Opt Out of (Almost) Everything!

After organizing my current email, I turned to a problem with both my personal and professional email – I am subscribed to WAY too many newsletters. For the last few weeks, I have been vigilant in unsubscribing from almost every newsletter service that has come across my inbox. I figured that if I really needed it, I could go back and resubscribe at a later date. This literally is over 100 that I have taken the time to remove, but after a few weeks of doing this, there is a massive difference in how many emails I receive daily. There’s also the added benefit of having less of my personal information out in the internet ether.

Protect Your Email Privacy

Maybe I’m a little late to the party, but I read this article about the Gmail app and some of the privacy concerns it has. It’s important to remember that if you have a free Gmail account that a massive amount of data gathering and tracking will occur. I haven’t yet moved exclusively over to my iCloud account (which everyone that has an Apple ID should have), but I am strongly considering it. As a half step, I have removed the Gmail app from my phone and pull my Gmail through the Apple Mail app.

I hope that these few small suggestions can help you uncover some ways to organize your digital life and reduce the amount of stress it can give you. Additionally, I have found that you will likely save money by removing many of the “sales” that are offered to you on a daily basis!

Clint Walkner