By Haddon Libby
The stock market is having its worst December since the Great Depression. While this is a great headline that grabs readers, should we fear that our economic good times are but a mirage? Could we be on the precipice of another crash like 1929 or 2008?
No. As you will see below, what we face today is nothing like either of those sad economic days of the past.
In getting started, you should know that the U.S. economy for 2018 is on track to log its best economic performance since Lyndon B. Johnson was president fifty years ago. To go from the best year in decades to a recession within months is a virtual economic impossibility.
We can expect that things will slowdown in 2019. To keep things in perspective, we are slowing from a 3%+ rate in 2018 to something in the 2.0% to 2.5% growth rate. That level of growth is hardly the start of the next Great Depression or Great Recession.
Rather than relying on logic, let’s use data and analytics to see if we should be concerned. To keep this simple, let’s look only at P/E ratios. P/E stands for the Stock Price per share divided Company Earnings per Share. Most refer to this as the Price-Earnings Ratio or P/E multiple. Companies that are growing quickly often have P/E multiples that can be very high while slower growing or shrinking businesses have lower P/E multiples.
Newscasts will often report that “the Dow” went up or down by some number. That number is the Dow Jones Industrial Average which tracks the performance of thirty of America’s top companies to create an index that gives us an idea as to the general health of the U.S. economy.
The Dow has gone from an 18.1 P/E multiple at the start of the year to a 13.8 P/E multiple which is below the long-term average of 15.6.
The S&P 500 Index includes most of the largest companies in America. The P/E multiple for this index went from 18.4 to 14.6 which is below its long-term average of 15.7.
Looking at the NASDAQ Index which focuses on technology companies, the P/E multiple declined from 22.3 to 18.2. While higher than the other two indexes, this industry is growing at a faster rate than other areas of the economy. With a long-term average of 17.5, the current valuation seems fair.
The big difference today that most seem to be missing is that we still have a low interest rate environment when looked at through the lenses of time.
With interest rates that are still low, valuations for stocks that are seemingly fair and an economy that is on track for a solid 2019, how could we possibly be on the verge of another Recession?
While this current uber-correction feels rotten, corrections like these are very important if we are to avoid the boom-bust cycles of the past. From a long-term perspective, this is a good thing although it doesn’t feel that way to investors when in the middle of a correction.
The economy and ultimately your investment portfolio are in a lot better condition than you might think.
The real risk at present relates to debt. Stay away from high debt companies that stoke their stock price with dividends and stock repurchases paid for with debt. Those stocks possess the highest risk.
If you are holding high yield debt or debt with maturities longer than seven years, consider reducing this exposure quickly as interest rates will be going up and these holdings will suffer the most.
For what it is worth, the average annual return for the S&P 500 over the last 90 years is 9.5%. P/E multiples tell us that these stocks are currently valued at a slight discount to average. That sounds more like an after Christmas discount than another Recession.
Haddon Libby is a Managing Partner and Fiduciary Advisor at Winslow Drake Investment Management and can be reached at Hlibby@WinslowDrake.com. For more information, please visit www.WinslowDrake.com.
