There is plenty to worry about in equity markets, and the primary concern is inflation. US inflation in October came in at 6.2% year on year, the highest in 31 years. Rising prices are evident across a broad range of goods and services, not just in the US but also in many other countries. Prices of energy and commodities such as agriculture are set mostly by world markets, and disruptions in supply chains and logistics are happening on a global scale.
Inflation typically eats into purchasing power and has a dampening effect on consumer spending. It also forces central banks to tighten monetary policy faster and sooner than expected, which would hurt the economic growth outlook. All these reasons make it easy to be bearish on the market — particularly given current valuations, which are higher than the historical average — to call for an imminent and material correction or worse. Yet, US stocks have not only remained broadly resilient, but all three bellwether indices — the Dow Jones Industrial Average, Standard & Poor’s 500 and Nasdaq Composite — are hovering near all-time highs.
A key factor underpinning the US stock market is the strength in corporate earnings. According to data provider FactSet, 92% of S&P 500 companies have reported 3Q2021 earnings up to Nov 12, of which 81% have beaten market expectations on profits. Significantly, net margin for the quarter now stands at 12.9%, on average, the second highest since FactSet started tracking the metric in 2008. The highest was recorded in 2Q2021 at 13.1%.
Clearly, businesses are not just benefitting from recovering demand — and economies of scale — but have also been able to pass on higher costs. And higher prices have yet to dent consumer spending. Case in point: US retail sales rose 0.8% month on month in September and an even stronger 1.7% in October, both prints topping market expectations. Granted, the numbers could have been boosted, in part, by pulled-forward demand as consumers heeded warnings to start holiday shopping early amid supply constraints. Still, robust consumer spending and abundant jobs should allay fears of stagflation in the US economy.
Another reason that stocks — and other speculative assets such as cryptocurrencies — are attractive is persistent negative real bond yields. Heightened demand for protection against inflation has driven real yields to record lows. Real yields on the benchmark 10-year Treasury Inflation Protected Securities (TIPS) were hovering at -1.1% to -1.2% at the point of writing. In fact, the entire real yield curve for US Treasuries is in negative territory. Some market observers think real yields could stay negative for years to come. Despite the spike in inflation rates, nominal yields remain very low from a long-term historical perspective.
The doomsayers will be right, at some point. We are certain the market will pull back; we just do not know for how long or how deep, or when that will happen. The truth is nobody knows, and attempting to time the market has rarely served anyone well over the longer term. Investors simply cannot afford to sit on the sidelines and wait for a market crash. This is why we generally keep our portfolio near fully invested, preferring to switch between broad sector themes. Regardless of the prevailing environment — inflation, deflation, rising interest rates, falling interest rates, boom or recession — some sectors and stocks will always outperform others.
Using the US stock market as an example, the S&P 500 index generated an annual return of 10.9%, on average, including dividends, over the last 30-year period. Bear in mind this is passive investing, simply holding the stocks in the entire index basket. If you are good at stock picking, it is quite likely your returns will be a few percentage points higher. For instance, the Global Portfolio’s compound annual growth rate (CAGR) since inception is more than 14%. With this kind of consistent long-term annual returns, it makes no sense trying to time the market — if you are on the sidelines, your returns are zero (and that is before taking inflation into account).
The performances of our most recent investments have been somewhat of a mixed bag. Airbnb has done very well, up 16.9% from our cost in five weeks. The global travel hosting platform beat market expectations in its latest quarterly earnings results — on the back of strong recovery in demand and higher average daily rates for its hosts. Interestingly, the company also noted a trend in longer-term stays, a month or longer, which it attributed to the remote work culture brought about by the pandemic. Airbnb thinks the ability to work from home, anywhere, anytime, could be a new flexibility that will be widely practised. With progress in Covid-19 vaccination and development of effective treatments, more travel restrictions will gradually be lifted around the world. We foresee huge pent-up demand, following two years of near-complete international border closures.
Strong consumer spending and travel normalisation should also bode well for Mastercard, which earns higher fees on cross-border transactions. The company expects to grow net revenue at a “high-teens” percentage compound annual growth rate (CAGR) from 2022 to 2024, and earnings per share CAGR in the “low-20s”. Mastercard’s share price has been quite volatile in recent weeks, however, perhaps mirroring investors’ ambivalent sentiment for payments stocks in general.
PayPal Holdings too has performed poorly — its share price fell sharply after reporting disappointing 3QFY2021 earnings and a weaker-than-expected outlook for 4QFY2021. The company was hurt by the loss of its status as the primary payments partner for eBay. Positively, the drag will cease in 2022. The development has also enabled it to partner with other e-commerce platforms. PayPal recently entered into an agreement with Amazon.com, whereby shoppers on the latter’s platform could use its digital wallet, Venmo, as a checkout option from 2022. This is part of the company’s efforts to monetise Venmo.
Meanwhile, Walt Disney Co too reported weaker-than-expected earnings in its latest quarter, sending its shares sharply lower. Analysts were most disappointed by slower growth for Disney+, which added just 2.1 million subscribers to 118.1 million. Nonetheless, Disney explained that growth would not be linear and has affirmed that it is on track to hitting 230 million to 260 million subscribers by 2024. Its share price reaction suggests that sentiment is very closely aligned to its streaming growth, even if Disney+ is expected to turn profitable only in 2024. Despite the earnings miss, we remain positive on the company. Subscriber growth should pick up pace, with the expected content ramp-up and new market launches. Importantly, we think the market is under-rating the recovery for its Parks and Experiences — the big cash and profit generators — which will continue to gain traction, especially with a gradual resumption in international travel. Management indicated that margins would improve from pre-pandemic levels because of the various enhancements made.
Shares in Home Depot and Builders FirstSource surged to record highs on the back of the robust housing market. Demand from professional contractors was a key driver behind Home Depot’s market-beating sales and earnings in its latest quarter. Consumer spending on home improvement too has remained strong, despite rising price tickets. Revenue grew 10% y-o-y, with total comparable sales up 6.1% y-o-y. Meanwhile, Builders has beaten consensus earnings for the past four straight quarters. Its value-added segment is doing well and the merger with BMC Stock Holdings has contributed positively. The company has indicated that it is actively looking for mergers and acquisitions to further expand the business.
The Global Portfolio gained 0.4% for the week ended Nov 17. The big gainers are General Motors Co (+9%), Home Depot (+7.1%) and Apple (+3.8%). On the other hand, shares in Walt Disney (-9.8%), JPMorgan Chase & Co (-1.9%) and Singapore Airlines (-1.8%) ended the week lower. Last week’s gains lifted total returns since inception to 70.8%. This portfolio is outperforming the benchmark MSCI World Net Return Index, which is up 63.8% over the same period.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
Photo: Bloomberg
