Cash Flow
In our commentary from last Tuesday, we discussed investing in the stock market versus investing in the market of stocks. Today, we will dig a bit more into the idea of investing in stocks. And offer a few thoughts regarding market prices as tracked by the indices as well as some thoughts about the economy.
We will review the benefit of utilizing dividend-paying stocks. Note that we limit the use of this approach to those clients who have asset margin. This means that our internal analysis of their situation suggests that their money will last longer than they do.
Economic Environment
According to the Bureau of Economic Analysis, or BEA, consumer spending increased in October, November, and December 2023, as well as in January 2024. Consumer spending in Q4 2023 totaled $15,575 billion. On a percentage basis however, spending growth is weak. According to the Bank of America Institute, lower income spending growth has slowed, but remains stronger than high-income household spending. This is due no doubt to the higher percentage of low-income household cash flow which is allocated to basic services, such as housing, transportation, and food.
What about businesses? The NFIB Small Business Optimism Index fell to 89.4 in February, its lowest level since May 2023. Survey results indicate that this is driven by the ongoing challenges of higher materials, labor, and financing costs. While most businesses expected an increase in sales, this increase was subdued relative to other periods of economic expansion. Larger firms? The number of companies who are borrowing, and who have access to credit at prime rates, is very low, compared to historical trends. In short, companies of all sizes aren’t borrowing. They are saving.
Last week, I was visiting with a friend. His company manufactures custom pressure vessels for the natural gas industry. He indicated that there is little activity at the well head. And that the various gas utilities are conserving cash, rather than making capital expenditures.
My take-away from all this? Households are saving money. Businesses are saving money. State and municipal governments are being very careful with debt, as unlike the federal government, they have limits on their spending.
Debt
At some point, all households, businesses, and state and local governments must balance their budgets. The exception to this? The federal government. Our federal government is ruled by a political/bureaucratic class which seems immune to accountability to the taxpayers which fund it and them. By way of example, the 2024 White House budget projected $5.08 trillion in revenue and $6.94 trillion in spending, for a 2024 deficit of $1.86 trillion. At the moment, the existing U.S. federal debt is about $35 trillion.
90 Day Treasury bills are yielding 5.2%. If the government is paying 5% on its debt, then annual debt service is $1,750 trillion. Or almost 35% of expected revenue for 2024. As this debt gets rolled over, and as annual deficits continue, the total indebtedness and the interest costs thereon will continue to absorb greater and greater portions of the annual budget.
Modern Monetary Theorists (MMT), or Magic Money Tree to some of us, posit that the government can spend without restraint, as long as they can control inflation. MMT has certainly been tested over the last two or three years, as inflation has reared its head. The theory of unlimited spending has a poor track record of success. Such hubris can only exist when you are playing with the world’s reserve currency, or by profession, delinked from the real world.
Other Data Bits
According to Lacy Hunt, an economist in private practice, the Federal budget deficit exceeded private and foreign saving in 2023. Hunt says this is only the 8th year since 1929 with negative net national saving (NNNS). In contrast to last year, all previous NNNS cases took place during extremely severe economic contractions. Four occurred during the Great Depression between 1931 and 1934 and the other three occurred during the Great Financial Crisis of 2008-2010.
I’ll attempt to summarize what this means. The short version is that an NNNS environment has a negative impact on savings, economic activity, and the growth of capital stock. It’s not good for the economy. At large or individually.
There are other multi-decade cycles at work. Ray Dalio describes five interrelated influences as how well money/debt/economic systems work, how well the internal systems within countries work, how well the world order/systems work between and among countries, the force of nature, and the impact of technology and innovation. We will write separately about megatrends, long cycles, and some of the books and authors who attempt to understand these things. However, they are having an impact and will continue to do so. Dalio’s article is titled “2024: A Pivotal Year on the Brink”, if you want to look it up.
What Are We Watching?
My view is that we are watching households, businesses, and those entities which must balance their budgets, take a very conservative fiscal approach. Low debt, significant cash reserves, and caution when it comes to business expansion. Why? Our take is that many of us are watching unbridled federal spending, a very unpleasant civil discourse, and a discouraging political landscape. And we want no part of it. And more than the political/bureaucratic class, understand that uncontrolled spending simply won’t end well.
Is there opportunity? Certainly. There is always opportunity. Though the ideal opportunities for us and all businesses are better if they are neither speculative nor debt fueled.
So What?
So, what does all this have to do with you and me and how we put our money to work? So glad you asked. One of my favorite quotes about money is from Will Rogers. He said that when it came to investing, he was always more concerned about the return of his money than the return on his money. Good point. And when we go through major cycles, being prudent with how we put money to work, more than at other times, is critical.
The Stock Market?
Where are we at the moment? Well, a few statistics. The Magnificent Seven, namely Microsoft (MSFT), Amazon (AMZN), Tesla (TSLA), Apple (AAPL), Nvidia (NVDA), Meta Platforms (META), and Alphabet (GOOG and GOOGL), represent 29% of the market cap of the S&P 500, with the other 493 companies sharing the remaining 71%. Those seven companies were up more than 50% last year. The S&P 500 was up 26% last year. Any portfolio without one or more of those seven companies was likely up in the low single digits.
Why discuss these seven companies? They are such a reminder of something called the “Nifty Fifty”. You’ll have to do some research to find the phrase and the companies. But in the ‘60’s, investors believed if they owned these 50 companies, then they were set for life. Where are those 50 companies today, 60 years later? A very few, such as Coke, McDonald’s, and IBM, exist as they did then. Most have been sold, merged, or gone out of business.
And those seven companies remind me even more of the late 90’s, just 25 years ago. What did you need to go public in the late 90’s, and have a massive market cap? Just make sure your company name ended with dotcom. Nothing else really. For those of you who weren’t there, that didn’t end well either.
FOMO, or fear of missing out, seems to be the current driver. For us, it would be much easier just to “buy something”. One of the M7. A crypto fund. Holland tulip bulbs. Perhaps a few shares in the Mississippi Fur Trading Company. But to sit in cash with some funds?
What Do We Do?
Yes, it’s boring. But it works. We buy companies with a proven track record of paying dividends. For decades. Three decades. Or five decades. Or even more than 100 years in some cases. Buy them when stock prices are low as compared to dividend yield.
Why this approach? Here’s our experience. First, this approach gives us solid long-term returns. Second, volatility is lower than buying an index. Investing in index funds, which are off 20% in a year, separates savers from investors. Since volatility is lower, the emotional impact of market movements isn’t as severe. Third, we get a cash return on our investment each quarter, rather than having to sell in order to monetize our gain. Cash dividends are a significant component of total return. And if we can build a portfolio with an average dividend of 4%, we don’t have to depend as heavily on price appreciation for long-term return. Fourth, many dividends are taxed at long-term gain rates. Fifth, unlike open-end mutual funds, whether index or actively managed, we have control over the timing of capital gains. The larger your taxable portfolio, the more tax management matters.
Discipline demands that we are careful with your funds and ours. To do our best to assure that when we put dollars to work, we are buying companies who have free cash flow, can manage their debt through various market cycles, and can consistently pay and grow their dividends. History can be an excellent guide in this regard. And if those companies aren’t available at prices we are willing to pay. Just sit in cash. Always remember that the higher the current price relative to earnings or other key metrics, the lower the future return, everything else being equal. This is the difference between price and value.
Summary
Control what you can control. Don’t worry about the rest of the world. Maintain your good habits, financial and otherwise. And enjoy this beautiful weather.
Until we see you again, wishing you only the best.