Crossroads

Sixty years ago my father was a high school principal. Salary, $10,000. With my mother he bought a house – two stories, four bedrooms, two baths, garage, big lot, stucco-on-brick in a small town just outside Toronto (now Mississauga). Price, $19,000.

I’ve no idea what the down payment was, but mortgages cost 8%. Within a decade they’d be almost 10%. To make ends meet, my parents took in a boarder, a nice young woman named Elizabeth. She taught me all I know about sex. (Just kidding. I was nine.)

The last time that house changed hands – renovated, but not expanded – the sale price was $1.8 million, or 100 times what my parents struggled with. The mortgage rate, however, was under 3% – less than half the historical norm. And a high school principal for the Peel District School Board (which my father eventually ran) earns $110,000.

So, salaries are ten times higher. A mortgage costs 60% less. House prices up a hundredfold.

How, then, did we lose our way over the decades? The answer is complex, including a massive increase in taxes (and the services people demand from government), a decade-long collapse in interest rates (pumping real estate) and a whole new attitude towards debt.

Today home ownership, house prices and mortgage borrowing are all at record levels. The wealth gap has widened as never before. As a direct result, politics are polarizing as people try to find solutions to an unsustainable financial situation. That’s bred a rush to protectionist populism in the States, and a drift left into a shared-economy, nanny state Canada. Neither are working. Or ever will.

More taxes just embellish government and impoverish citizens. Higher interest rates transfer further wealth from the middle to the top 1%. Trade wars whack everybody. The tribalism coming from the alt right/Trumpers is based on barriers – impossible to firewall in a Google world. The socialism of the lefties is another failed doctrine destined to kill investment, initiative and employment. Truly, we’re reached a crossroads.

Debate is useful but not a substitute for action. Moisters need to realize no government will produce houses that cost two times annual income in a major urban area. Those days died with my old man. Boomers must prepare for decades of volatility ahead, just when their working years are over and they’re most vulnerable. For those in the middle, now struggling with real estate burden, mid-career pressures, fading pensions and family costs, just getting by is no strategy.

Heed the lessons posted here. Don’t just do what everybody else does – since most of them are verifiably pooched. Stop borrowing. Seek balance. Don’t have a one-asset financial strategy. Use the generous tax shelters gifted to you. Stay single or stay married. Understand investing is not gambling. Be diversified. Don’t consume what you cannot afford. Don’t envy the wealthy, emulate them. Embrace some risk, if you want returns. Ignore FOMO. Don’t just save. Understand how you’re taxed, to avoid it. Plan. Be conservative and aggressive. Have global exposure. Find and keep one good friend. Besides the dog.

Above all, value your time. Waste none. Like $19,000 real estate, it’s not coming back. Every moment you spend wishing otherwise is a debit.

The minutes I devoted writing the above were an investment in you. Run with it.

Mother’s milk

RYANBy Guest Blogger Ryan Lewenza

Larry Kudlow, Trump’s key economic advisor, and one of the more reasonable economic minds in his administration, is famous for saying “profits are the mother’s milk of stock prices”. Meaning, where profits go, generally goes the stock market.

This can be seen in the chart below which overlays the S&P 500 with the index’s earnings going back decades. This simple but important chart captures the strong relationship between stock prices and earnings over the long run. Further hitting home this point is the fact that, since the 1950s, earnings growth for the S&P 500 has averaged 7.5% annually, which is roughly the average yearly price return of the S&P 500. We can slice the data a number of ways and it all comes back to the fact that earnings drive stock prices over the long run.

So what’s happening with corporate profits?

Where Earnings Go, Stocks Go

Source: Bloomberg, Turner Investments

In short, they are on fire!

Following the earnings recession of 2015-16, S&P 500 earnings have surged hitting new all-time highs in the process. S&P 500 Y/Y earnings growth has averaged 16% since 2017 with Q1/18 earnings growing at an impressive 20%, marking the strongest earnings growth rate since 2011.

This quarter analysts are projecting earnings to rise 17% Y/Y, however, given the recent historical beat rate of 4% (earnings have beaten analyst’s estimates by 4%), I see earnings growing at roughly 20% Y/Y again this quarter. This is incredible and is very supportive to stock prices.

The strong earnings growth is being driven by a combination of robust revenue growth (7-8% over the last few quarters), continued high margins, stock buybacks and a lower corporate tax rate following last year’s historic US tax reform.

Strong Earnings Growth Expected for Q2/18

Source: Bloomberg, Turner Investments

A common talking point among analysts and the media is that earnings are going to peak soon and that this will be the final nail in the coffin for this bull market. This has been the most hated bull market in history with one excuse after another supporting an imminent bear market sell-off. To cite just a few: end of Fed’s QE policies, high valuations, record debt levels, Trump, trade war, Brexit, Greece, etc. We agree that earnings are of course going to peak, as nothing lasts forever, but we see this as more of a 2019 or 2020 story.

One reason I believe this trend of strong earnings can continue is because of what we are seeing with analyst’s earnings revisions. Typically, analysts start out with high expectations at the beginning of the year then revise them lower over the year. You can see this typical pattern in the chart below. This year we saw the opposite with S&P 500 earnings being revised significantly higher from US$148/share at the beginning of the year to US$159/share currently. The positive earnings revisions reflect stronger US and global growth and the much lower corporate tax rate for this year.

Typically Estimates Are Revised Lower – Not This Year!

Source: Bloomberg, Turner Investments

Right now we’re getting bombarded with lots of headline risk, much of it emanating out of 1600 Pennsylvania Ave. So during these hectic periods it’s critically important to refocus on the fundamentals. The US and global economy remain strong right now and corporate profits are hitting new all-time highs. If Trump can get out of the way with his escalating trade war (and save himself), stocks should continue to gain in the second half of the year on these robust corporate profits.

Ryan Lewenza, CFA,CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.