Around ten years ago on a trip to Disney World, I was the first in the family to earn the designation “Galactic Hero” on the Buzz Lightyear Space Ranger Spin scoring 999,999. Of course, my boys, as competitive video gamers, would not be outdone and insisted on using Magic Hours and every Fast Pass in an attempt to match their father’s glorified and skilled status.
Fast forward to a recent trip to Disney World this past August with my goddaughter, where we came upon the Galactic Hero himself signing autographs for the other Zurg haters in attendance. Taking Buzz’s motto to heart, the U.S. economy and large cap equity prices at quarter end also appeared headed “to infinity and beyond!” Second quarter Real Gross Domestic Product (GDP) grew by a robust 4.7% and the ISM Manufacturing Index, Consumer Confidence and Small Business Optimism have united to push the GDPNow estimates for the third quarter to similar levels.
Although we are far along into the economic recovery, third quarter S&P 500 revenue grew 10.3% year-over-year (the fastest pace since the third quarter of 2011), and earnings benefitted from record profit margins and lower taxes, soaring over 20%. Employment data corroborate overall economic strength as survey responses to “jobs hard to get” plunged to just 12.7% in August, the lowest since March 2001. The unemployment rate also dipped to 3.7% in September, reaching its lowest level in 49 years.
Princesses and Galactic Heroes
All of this late cycle growth, especially when accompanied by little employment slack, has quietly begun to encourage the Evil-Emperor’s nasty cousin — inflation. Hourly wage growth at 2.8% in September was near the cycle’s high growth rate and the year-over-year change in the Consumer Price Index (CPI) at 2.9% is the fastest pace since December 2011.
Virtually none of this cyclicality and inflation occurred during the reign of our prior Federal Reserve Heroine, Princess Yellen, as her timely passing of responsibilities to our new Galactic Hero, Jerome Powell, places him in a difficult battle. Governor Powell’s task of containing inflation while maintaining full employment is becoming exceedingly more difficult.
Given the growing level of inflation and lessening amount of slack in the economy, it’s almost certain that the Federal Reserve will continue tightening beyond September’s 0.25% raise in the Fed Fund’s rate to 2.25%. This eighth rate increase in the short-term rate (its first foray above the magical target of 2% inflation rate) seems to denote the transition from “accommodative policy”, where rates below inflation encourage investment, to “neutral or restrictive policy” where rates above inflation discourage investment. Monetary nuance aside, the Fed is no longer “Mickey Mouse-ing around.” (Ok, that was the worst metaphor I have ever used in an Investment Perspective, but I had to do it!)
Eating Around the World Showcase
No trip to Disney is complete without a sampling of food at Epcot, and we were fortunate enough to be there during the first day of the Epcot International Food and Wine Festival. Always up for a meaningless arbitrary Disney challenge, the four adults successfully ate their way around the World Showcase earning country stamps to fill in our Epcot Passport.
As a value and quality (and business momentum) investor and eater, I cannot help but compare U.S. equity opportunities with those found abroad. So far this year, investors have gobbled up large cap U.S. equities catapulting the S&P 500 up 9.4% through September versus the less appetizing foreign companies, which were down 2.7%.
The ongoing outperformance of U.S. equities has driven their relative price/earnings ratio (P/E) to a 12% premium to an MSCI index of 22 developed and 24 emerging markets. This gap, the largest since 2009, reflects both relative total return performance and evolving differences in the growth and quality components of each underlying index.
For instance, Facebook, Apple, Amazon and Google (FAANG) and other high growth technology companies have risen up the market capitalization charts here (and to a lesser extent in China) while virtually no high-tech companies have emerged in other developed equity markets.
Technology’s weighting in the Russell 3000 at 20.7% is more than two times its weighting in the MSCI All World less US index. Thus, the cheapness of foreign stocks is not merely a reflection of their poor price performance, but also a reflection of U.S. companies’ ability to outgrow in both revenue and earnings. Unfortunately, just shifting your asset allocation to International is not a simple, bulletproof decision.
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The S&P 500 measures the performance of the 500 leading companies in leading industries of the U.S. economy, capturing 75% of U.S. equities.
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