Volatility Clouds Tug of War Between Earnings and Interest Rates
From a purely economic standpoint, future market movement should come down to the result of a tug of war between earnings and interest rates. For some time now, we have been seeing companies report exceptionally good earnings that – especially in light of historically low interest rates for years – have continued to fuel a rise in the markets. According to FactSet Earnings Insight for April 6, the estimated Standard & Poor’s 500 earnings growth rate for the first quarter is 17.1 percent.
On the other hand, the Federal Reserve has made it clear that it will increase interest rates, and that could be a drag on market growth in a couple of ways. Higher interest rates will make it more expensive for companies to borrow money for expansion. In addition, the Congressional Budget Office predicts the federal budget deficit will hit $1 trillion by 2020, largely because of recent tax cuts and spending increases. Rising interest rates will make it more expensive for the government to finance this debt, which in turn could lead to higher inflation and have a dampening effect on economic growth.
In the short term, concerns about the deficit as well as worries about potential trade wars have helped to fuel levels of market volatility that have not been seen in years. And some investors are getting nervous.
In times like these, it can be helpful to review the historic performance of different types of investments. According to Ibbotson, from 1926 to 2013, the compound before-tax annual return for stocks was more than 10 percent, while the return for bonds was 5.5 percent. Of course, there were periods of time when stocks underperformed bonds, so investors need to be aware of when they will need to draw on their investments. And there is the usual caveat that past performance is no guarantee of future results.
Some investors tend to divest equities when the market is volatile. However, it is very difficult to decide exactly when to exit the stock market – and when to get back in. History shows that most investors leave too late and then return too late, thereby suffering a significant portion of the losses and missing a significant portion of the gains.
At Peachtree Investment Partners, we don’t believe in timing the markets. We believe in working to build portfolios designed to provide the best likelihood of good returns and limited volatility. Of course, no approach is guaranteed, which is why we spend considerable time talking to our clients about what they need and expect from their investments.
Our focus is primarily on large U.S. companies that have a record of good cash flow and return on investment capital, and a consistent record of growth in revenue and earnings. We also strongly favor companies that pay dividends. Regular, reinvested dividends can contribute substantially to long-term returns. They also can help to mitigate volatility because returns are not based solely on movement of stock prices.
Every investor’s situation is unique in terms of the amount of volatility he or she can afford – or accept – in a portfolio. But we think that a carefully planned approach that focuses on the long term can help you sleep at night.
Garry K. Schaefer
Atlanta, Georgia
April 24, 2018
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