Video: A Decade in Review

Hello, my name's John Sanderson, President of Sanderson Wealth Management. And what I'm going to do with you today is look back at the last decade for investments, the economy, and then have a bit of a look forward. If you went back 10 years from now, we were all feeling a little bit bruised and poor. The reason being we had just went through the great recession and at this point in time, 10 years ago, we were still concerned that the world's financial system could actually fail because of the subprime crisis. A recession is defined as two quarters in a row of negative economic growth. And as you can see on the screen, we actually had four quarters in a row. The US economy actually shrunk by 4% which is a pretty deep reduction. We've all been used to the stock market doing well recently. But here's a reminder that the S&P 500 can go down and it can go down a lot and relatively fast.

The market drop between October 7th, 2007 and March 9th, 2009 57% so yes, Virginia, the US market does decline at times. Fast forward to right now. All of us are now feeling pretty good. We've just had 10 years of a pretty good stock market. The economy's good, employment's good and so on. Along this line, the reason being, we just had 10 years of economic growth. The last time this happened was the 1960s and in fact, we did not have to invest our young people in the Vietnam war to do it. We grew at an average of 2.3% so it wasn't robust, but very good. And 2.3% is actually a very good growth now. In the 60s and 70s when we had higher growth, the employment force was growing by 1.8% it's now growing by about 0.4%. Also looking at the S&P, you can see that it in fact rocketed it up and as we'll talk about later, it's up 253% but you can also see there were some pretty good dips along the way.

The expansion in the economy is now in its 128th month. That's the longest expansion in history and expansion doesn't die from age but from excesses and so far we haven't attached any excesses to this economy. To put this in perspective, the average expansion since World War II is 58 months and the average contraction is 11 months. The US economy grew 25% over the last decade, which is solid. Foreign developed, which is primarily Japan, Europe and Australia grew only 15% emerging markets dwarf the developed world by growing 62% and this is a theme that I'm going to repeat through the presentation. How did these growths affect the worldwide total stock market? In 2009 the US represented 25.8% of the world's stock market. It now represents 26.7 so we actually grew in proportion. Foreign developed on the other hand, dropped from 44.1 to 33.7 emerging markets grew from 30% to 39.5%. Some of this growth is attributable to the increase in the value of the dollar, but basically it's a reflection of the growth in our economy.

Employment was also good during the last decade. We created jobs in every year. We've now created jobs in 112 straight months. That is a record. Unemployment dropped from 9.9% to the current three six and the couple of months prior to this, it was as low as 3.5 and we're doing this without a major war. During this decade we created 22 million jobs, a stunning amount. As far as wages, wages increased all 10 years, but early in this decade it was relatively low and sub inflation. The last three years while minimums picked up, it went up 2.4% in 18, 3% in 17, 3% in 18 and 3.4% in 2019 this wage increase has happened without creating inflation. Household net worth has soared from $65 trillion to about 115 trillion, so in general, wages are up 27%, net worth up 81% this sort of reflects some of the increasing gap of wealth in our economy. One of the things that went up and affected a lot of people were homes.

From the low in the market, the price of homes are actually up 54%. During the decade, it's up 45% a very meaningful increase. As far as the stock market goes. The US market went up a stunning 253% over the last decade. Foreign developed did well but much worse at 99% and emerging markets were 83%. One of the things people follow is the economy versus the stock market and what I want to illustrate in the long run, the stock market does follow the economy but not on a year by year basis.

 

We had economic growth all 10 years, yet one of the years 2018 we actually had a negative stock market and 2013 we had a very low 1.8% growth compared to the other years, but yet we had the highest return in the stock market of 32.3. And 2018 we had the highest growth in the last 10 years, yet we actually had a negative market of minus 4.4. And 2019 we had the decades average growth of 2.3% yet we had a return in the S&P 500 of 31.4. One of the things we like to point out is that sometimes people pay too much attention to short term movements in the stock market.

So as we just pointed out, nine out of the 10 years the market was positive and overall it went up 253% yet in many of the years, there was material inner year drops. In 2010 for instance, we had a 15.6% drop in the market and we ended up 15% for the year. In 2011 a relatively scary 18.6 almost a full 20% bear market yet we ended up 2.1%. And 2015 a 12% drop, we still came positive one four, and if you look at 18 with a good economy, we still had a 19.4% drop to finish minus 4.4. Last year we made 31.4% and everybody's very happy at the end of the year. But I like to point out that in May there was such concern over the US China trade war, the US market lost six and the world market lost 8.5% in that one month.

Now, with these things in mind, how has capitalization gone in the world markets? In 2009 the US stock market was 42% of the value of the world's market. 10 years later, we've increased to 55.6% of the world's stock market. Foreign developed has dropped from 45.3 to 32 to in emerging markets in spite of a 62% growth in GDP dropped from 12.6 to 12.2. So the US produces 27% of the world's goods and services, yet has 56% of the investible universe. Whereas emerging markets produce 40% of the goods and services and only 12% of the investible universe. It's anticipated that the emerging markets will continue to grow the fastest of the three blocks of the world's economy. As such, we would anticipate going forward that the emerging markets rate of return should beat the US rate of return and they should come closer together over time.

Now, how did we get this 10 years of growth and 10 years of good stock market? Well, one of the ways we got it was a decade of low interest rates. So going back to 1970 to 2009 the average 10 year government bond was 7.3% a relatively attractive return and also a relatively high cost for a government to borrow. The last 10 years, it's averaged only 2.4% this affects, by the way, mortgage rates. We had three clients last year buy $2 million second homes and all three got 30 year mortgages at 3% I would not have believed that possible 10 years ago. The federal reserve action, what happened in the great recession and people have forgotten this, we were actually worried that the world's financial system could collapse. This is the first time we had that kind of worry since the great depression. The US government did a little bit of fiscal stimulus. It passed TARP for $700 billion. The Bush administration was allowed to spend 350 billion.

The Obama administration, another 350 that was not enough to swing the US and certainly the world economy out of the doldrums of the great recession. So the world's central banks led by the US federal reserve lowered interest rates in the US case from 2009 to 2015 about to zero. We then started a normalization path which took the interest rates just under 3%. We've paused at the end of 2018 the beginning of 2019. For us in this business, we thought in late 2018 there'd be three additional interest rate increases in 2019 and instead we had the Powell pivot wherein he said he'd, we're going to stop raising rates in January, 2019 and in fact we ended up with three interest rate cuts. The federal reserve also did another thing beyond taking interest rates to close to zero. They went out and did quantitative easing. By this we mean they went out in the market, bought bonds, push cash into the market.

They had hoped that this cash would be used to hire people, build buildings, do equipment. A lot of the cash was used for other things then that such as buy backs and we'll talk about that. We stopped doing the quantitative easing in the US several years ago. As you can see on the chart, and in fact we were doing quantitative tightening into 2018 what you'll see at the end here we are building the balance sheet again, what happened there was a disruption in the repo market and the federal reserve started buying T-bills to help this situation. So you can see the balance sheet is growing again. Now, what happened as a result of these low interest rates? Let's focus on double B bonds. That's the highest grade of high yield bonds. Some people call them junk bonds. From 1997 to 2009 you were paid 8.3% to invest in this area.

Currently you're only paid 3.8% in our opinion, that's insufficient to cover the credit risk of a double B bond. Stock buy backs, as I mentioned. During the last decade, there was low interest rates. There was a tax cut and there was a lot of cash being generated by the S&P 500 they used an awful lot of this cash to go out and buy shares of stocks. What does that do? Well, that doesn't do a thing for the economy in that it's not paying for R&D. It's not hiring people and it's not building plants and equipment. What it is doing is reducing the number of shares out. If you reduce the number of shares, you increase earnings per share. If you increase earnings per share, you increase the value of the stock and the options and therefore you really enhance the compensation of the executives in these public companies. We call it financial engineering.

$5 trillion was spent on that over the last 10 years. Another thing that happened was a reduction in the corporate tax rate. If you go back before 2017 the US effective corporate tax rate was 39.2% that's 35% federal and effectively 4.2% for state taxes. As you can see, it was not very competitive with our industrialized peers. So we put through a tax act and reduce the US Corp rate to 21% you still have about 4.8% effective state rate, so it's now 25.8 extremely competitive. My guess is it's more competitive than it has to be and therefore I wouldn't be surprised if it increases in the past and the future to help control the deficit. Effective tax rates were noticeably reduced. So this is what's reported by the S&P 500 before the 2017 act. The effective tax rate was 26.4 it's now 17.7 that's obviously a significant drop in something that can't be repeated.

The profit in sales, how did we do for that over the last 10 years? Well, profit as you can see was actually negative in two years and very positive in two years and overall it averaged a very healthy increase of 10.5% per year. Sales on the other hand were also positive eight out of the 10 years, but they averaged only four and a half percent so when you figure inflation of 2% sales only compounded at 2.5% per year over the last 10 years. Now in spite of that, as we mentioned earlier, the US stock market went up 253% with only two and a half percent per year increase in sales and 10 and a half percent per year increase in profit. So the US stocks probably got more expensive. Let's look at some common measurements.

The US stock market is currently selling at 3.7 times book value. Foreign developed and emerging markets are both selling at 1.7 times. Price to cash flow, an important statistic US is selling at 15.2 foreign developed and emerging markets at 9.3 times cash flow. A lot of people talk about 12 months trailing PE ratios. The US is currently selling at 24.2 the long-term average is 17.7. Now you can justify being higher than 17.7 because we have both low inflation and low interest rates. How much more than 24.2 we can justify is questionable however.

If you look at foreign developed in emerging markets for comparison they're 16.3 and 15 times 12 months trailing earnings. Another ratio we like to see is the 10 year PE ratio also called the Shiller Index. This has some pretty good predictive ability and looking at future stock market prices. Currently it's at 30.8 the long-term average is 19.1 a significant increase and for comparison purposes foreign developed are 17.3 and emerging markets 13.4 therefore, in all four of these measurements, the US looks to be fully valued if not overvalued and the only real justification for increasing prices going forward is increased earnings.

 

An interesting thing happened over this last decade, so we just talked about a decade where you had economic growth and each year you had a record string of increased jobs. You have a record low unemployment, yet the public debt has increased from 12 point $3 trillion to 23.2. In fact, we're running in excess of trillion dollar deficits. It's not hurting too bad right now because interest rates are so low, it will hurt a lot more in the future as it builds and as interest rates go up. It's been proven over time that once your public debt is greater than 90% of your GDP, it slows down a country's ability to grow. Private sector debt in the business area, it went up from $10 trillion to 16 trillion. Part of that is just a choice of businesses on where to get cheap capital with the low interest rates. Households had a modest increase from 14 trillion and it just passed $16 trillion.

This means our households are relatively strong. This is important because in the US our economy is 70% driven by consumers. The US consumer is really the engine that drives the world economy. Student debt, on the other hand, went up from about $225 billion to approximately $1.3 trillion a quadrupling. This is an important statistic because it's causing many young people to have difficulties in securing mortgages to buy homes. Also, it's becoming a political issue in that trying to address student debt is something many politicians are looking at and the recent Secure Act, you're now allowed to use $10,000 to help pay off student debt, but that's a pittance for most students. The US dollar has periods of strength and periods of weakness. Over the last 10 years in part because we were the first country to fully address the great recession, the relative value of the US dollar has generally increased.

That makes foreign investments for US investors less attractive. We would anticipate over time that the US dollar will start a period of weakening. As you can see, this is cyclical, that will aid us investors investing in foreign securities. This last slide is one of my favorites and I think it's very important. They tell you that past returns don't matter. But history is important. It may not repeat, but it'll rhyme. We think the current stock market has some historical comparisons. If you look at 1995 to 1999 the US market for five years compounded at 28.6% it went up 251% heavily driven by seven technology companies at this period of time is when people started saying, let's just invest in the S&P 500 Index and life will be good in the future. What happened to people that bought the S&P Index in late 1999? Well, for the next 10 years, they actually lost 9% the first five years it was the worst category.

It lost 11% and the next five years it went up 2.1%. Let's compare that with emerging markets. Who the heck would want to buy emerging markets in 1999? For five years, they only went up 10.4% whereas US large caps went up 25 times more than that. Well, for the next five years, emerging markets made 25.3%, 36% more than the US and the five-years after that, they were basically the best risk category. They went up 109% while the US only went up 2.1. Right now we're starting to hear from clients and competitors that, jeez, you did really well if you bought US large cap stocks, particularly US large cap stocks, and that's very true and you can see that over the last five years they've went up 73.9 which is a pittance compared to the 251 in the last five years of the 90s but a similarity is it's been driven by the FANG stocks, Facebook, Apple, Netflix and Google and other technologies.

So there's a very good comparison. We don't know for sure what's going to happen over the next five or 10 years, but based on the pricing that we just talked about, based on the growth of the emerging markets economies, we would think it would be unlikely that the US large caps will lead the pack going forward. Nobody really knows what's going to be the best category to invest on a going forward basis. We are big believers in staying diversified. It seems to us that many times when people look in the mirror to see what to invest in, they're wrong. It's very important. Keep diversified over the long run. You'll do well in that regard. Thank you very much.