Back to Basics

Last week I took a golf lesson for the first time  since playing golf in college, more than 20 years ago. The instructor began with the basics—grip, stance and alignment. If you play golf you know that golfers typically focus on a lot of items other than grip, stance and alignment. But these  three items are the key to the basics of golf. Over the years I have self-corrected my swing to the detriment of these basics. However, since I have addressed these three correctly, I’m gaining at least 10 yards on my golf shots. This next month may be rough as I retrain my body to correctly apply the basics.

There are also a few key basics when it comes to investing.  The key ones are valuation, growth opportunities and company debt levels. It is very easy to get caught up in the headlines—What will the Federal Reserve do with interest rates? What is happening with trade negotiations between the U.S. and China?—These items could certainly impact corporate growth opportunities and debt levels. In the midst of these headlines, however, it is important to revisit the basics.

Valuation.  Stock prices appear overpriced versus current earnings trends. The chart below looks at S&P 500 change in trailing 12-month earnings per share (EPS) versus change in price. The price change line in light blue has risen well above the trailing EPS in dark blue. We reviewed this chart in the newsletter six months ago.  At that time both blue lines were right on top of one another, indicating that stock prices were in line with earningsgrowth. We have seen a strong rally in stock prices since that time, bringing prices back to lofty levels that may indicate overvaluation.

Growth Opportunities.  FactSet projects that earnings will drop 2.6% year-over-year in the second quarter of 2019. If this materializes it will be the first back-to-back earnings drop since 2016. Earnings growth expectations differ widely among the eleven major Standard & Poor’s 500 sectors, with six sectors expected to grow (led by defensive Utilities and Health Care) and five expected to decline (led by Materials and Information Technology).

Company Debt Levels. The Federal Deposit Insurance Corporation (FDIC) tracks all loans and leases by all banks in the United States. There is currently over $10 trillion in loans and leases outstanding as of the end of the first quarter. Although the value of loans and leases has been rising steadily, the amount of loans not current on their payments has dropped steadily since peaking in 2010. At current rates, debt does not appear to be a significant issue; however, that can change quickly if economic conditions weaken.

Current investment basics indicate that caution is warranted with the stock market at the current time. Despite positive headlines, we need to focus on the basics and be prepared for potential short-term weakness. While caution is warranted, there is never a bad time to invest for the long-term. As we plan together we are focused on how your money can meet your goals. When building your financial future it’s always better to save rather than spend.