Are there Monsters Under the Bed?

The business headlines are covered with stories of last year’s sexy darlings tumbling out of bed. Crypto coins, miners and brokers have fallen as much as -80%, most SPAC’s (blank-check Special Purpose Acquisition Companies) are way below their initial offering prices, Chinese Internet stocks are down -70%, and the “meme” stocks like GameStop are off about -65%. Not to mention the outright false pricing and theft occurring with NFT’s (Non-Fungible Tokens) and digital properties in various Metaverse virtual reality worlds like Sandbox and Decentraland. When previously high-flying investments fall out of bed, it is an especially good time to make sure there are no surprises lurking in a portfolio. The Dow Jones Industrial Average and S&P 500 are down -9% and -14% for 2022 respectively, and the technology-focused NASDAQ has fallen consistently since last fall, so maintaining portfolio quality is critical as we move through 2022.

A good starting point is to evaluate the S&P 500 to see how stocks compare. Companies are facing rising interest rates and persistent inflationary pressures. There are actually 504 stocks in the index since there are four companies with two different share classes (Google, Fox, News Corp, and Under Armour). Companies are facing rising borrowing costs as the Federal Reserve raises interest rates and slows bond purchases, so debt:equity is a good ratio to review. Companies with excessive outstanding debt eventually have to pay off their loans, which becomes a drag on earnings. As of today, there are only 18 companies in the S&P 500 with zero debt, and there are a whopping 152 companies that owe more in debt that the total equity value of the company. Persistent inflationary pressure will challenge companies in delivering consistent earnings growth. There are only 90 companies in the S&P 500 with 5-year earning-per-share growth above +25%, and 183 are below +5%, with 19 that are negative. Out of 500 companies, wouldn’t it be better to choose financially sound companies with strong balance sheets and consistently growing earnings? Index funds are a great vehicle for those just starting to invest in the stock market. We use SPY, the S&P 500 ETF (Exchange Traded Fund) as a way to make tactical moves into the market at opportune times. But the core of the money we manage on behalf of clients is invested in concentrated portfolios of stocks with little or no debt, good earnings growth and rock-solid cash-flow.

There are many ways to construct portfolios and select stocks that deliver solid performance over time. In my opinion, and what has consistently worked well for both the Pawleys Dividend Fund and the Pawleys Growth Fund, is to balance sector weightings and choose stocks of companies with little or no debt, good earnings growth, and rock-solid cash flow. We don’t beat the markets every year, but the exceptional long-term numbers speak for themselves, and our clients can sleep well.

Source: yahoo! finance, Refinitiv

Alexander Hamilton and Bitcoin

What would Alexander Hamilton, the first Secretary of the U.S. Treasury, think about Bitcoin?  Last week I visited the Virgin Islands, sailing past Nevis where he was born, and pondered this question.  The current Secretary of the Treasury, Janet Yellen, has said that she has concerns about cryptocurrencies, yet also sees benefits.  The Chairman of the Securities and Exchange Commission, Gary Gensler, teaches a course on Blockchain and Money at MIT, and is an advocate.  The role of the Treasury is to issue money, oversee tax payments, supervise banks, and manage the finances of the government.  The role of the Securities and Exchange Commission is to oversee the raising of money and issuance of securities.  Regulators are struggling with cryptocurrency and how to define it, and thus how to regulate it. 

Currency by definition is a unit of account, store of value, and medium of exchange.  In order to be an effective medium of exchange a currency should be stable, unlike Bitcoin which has been extremely volatile.  Securities, on the other hand, are issued by public and private entities and typically trade on centralized exchanges.  As of 2014, the IRS has stated that capital gains taxation applies to what they refer to as “virtual currency,” or cryptocurrency, supporting it being a security.

Hamilton believed that ownership and economic safety were requisites to liberty, and spearheaded the birth of central banking and the issuance of currency.  In 1790, he launched the Revenue Cutter Service, which ultimately became the Coast Guard, to protect the public against “breaches of the Revenue laws.”  You could say that centralization is about not just control, but also protection.  Bitcoin is decentralized, and proponents value privacy and rail against centralization and governmental control.  Centralization provides protection – if my Visa card is lost and used by someone else, I am not responsible for those purchases.  But if a Bitcoin holder lose a private key for their wallet, their tokens are lost forever and they have no recourse.  Hamilton was very aware of the delicate balance between control and protection.  He stated in his instructions to the Cutter Officers: “(our) countrymen are freemen, and, as such, are impatient of everything that bears the least mark of a domineering spirit.”

Hamilton was an innovator, so if he were alive today, might be a proponent of Bitcoin.  But if he were sailing on a Revenue Cutter today, I am confident he would be on the lookout for pirates smuggling square groupers in exchange for Bitcoin – “keeping a careful eye upon the motions of coasting vessels, without, however, interrupting or embarrassing them unless where some strong ground of suspicion requires that they should be visited and examined.”  And he would reiterate cautious words about the important balance between control and protection.

Nevis, Leeward Islands West Indies

Sources: CNBC, yahoo! finance, IRS, Hamilton First Report on the Public Credit and Letter to Revenue Cutter Officers, June 4th, 1791

Comments from Pawleys – Ukraine, the Fed, and the Stock Markets

The Russian invasion of Ukraine is heartbreaking, and it is absolutely unbelievable that Putin believes he is justified in his actions.  On the bright side of this very dark event, we have seen a global galvanization against his actions, and Europe has united in a way not seen for decades.  Political and military experts have suggested that the conflict may end in a few short weeks, while others see this evolving into a longer-term situation.  So how does this affect the stock markets and what interest rate action the Federal Reserve will take this week?  In an effort to improve transparency and deliver a more consistent interest rate policy, Fed Chair Jerome Powell has signalled that there will be a 25 basis point increase in the Fed Funds rate this week, while previously many anticipated a 50 basis point hike.  He has also indicated that the uncertainty of the situation in the Ukraine, in addition to the unknown impact of sanctions, will cause the Fed to be very data dependent going forward and steer with a steady hand.

Since 1950, there have been twelve Fed rate hike cycles, and in the subsequent 12 months the market has risen an average of +9%.  Only once was the stock market negative, during 1972-1974, when the underlying economy was in recession.  Typically when the economy is growing, the stock market falls about -15% at some point each year, often catalyzed by an unforeseen geo-political event.  When this happens, we recommend that clients who have available cash and the appropriate risk tolerance to add to equity holdings.  We took this action in 2011, 2015, 2018, and 2020.  Last year the market only dipped about -5%, so I noted that we would likely see the market fall around -15% during 2022, which as long as the economy is still healthy, represents an opportunity for many investors.  As long as the Leading Economic Indicators are rising and the U.S. Treasury yield curve is upward sloping , the economy and markets will likely continue to do well 6-12 months in the future.  Both of these conditions exist today, which bodes well for the markets going forward.

The best way to protect a portfolio during uncertain times, in my opinion, is to hold stocks of very high-quality companies with little or no debt, good earnings growth, and rock-solid cash-flow.  Since the founding of Pawleys Investment Advisors in 2010, we have been through very challenging geo-political times, and our portfolios have held up very, very well.  I am watching the situation in Ukraine, the Fed, corporate earnings, and the underlying economy with vigilance.  High quality blue-chip dividend stocks continue to be the single best way to grow wealth and meet financial goals.  It is important to keep in mind any life changes that may affect how portfolios should be managed. Please keep your questions coming – we work hard to keep relevant information flowing, and want to make sure to address what is on everyone’s mind.

Source: S&P