Boyar Value Group letter for the second quarter ended June 30, 2016.
Boyar Value Group – Some Thoughts About The Market
The two-day decline in the U.S. stock market subsequent to Great Britain’s decision to exit the European Union saw the Dow Jones Industrial Average plummet by 871 points. However, it climbed 809 points in the next four days and continued its ascent thereafter.
This leaves investors in a familiar quandary: Questioning what catalysts could spur the market to new highs. In our last quarterly letter, we mentioned the Federal Reserve had forecasted four interest rate hikes for 2016. We opined that in all likelihood there would be only one additional rate hike, and that might not come until after the presidential election. The fragile global economic outlook coupled with anemic domestic growth has caused the Fed to temper its interest rate outlook. With all the global uncertainties we believe there is a high degree of probability no rate increase will occur until at least 2017.
Interest rates worldwide are at historically low levels. From 1958 through the present, the average U.S. 10-year treasury yield was 6.19% versus 1.49% as of the end of the most recent quarter. Central Banks in an effort to stimulate their economies are driving interest rates lower and lower. Amazingly, according to J.P. Morgan Asset Management, 74% of sovereign debt outstanding currently yields below 1% and 36% of government bonds have negative yields.
Dividend Income versus Fixed Income
It is highly unusual for dividend returns to be significantly higher than government bond yields. When it occurred in the 1950’s, investors who bought stocks whose dividends yielded more than bonds were richly rewarded. We are confident that history will once again repeat itself, and patient long term investors who purchase a basket of dividend paying stocks that have the capability of increasing their payouts will significantly outperform bonds over the next five to ten years.
It is critically important for investors to understand the importance of dividend payments to long-term stock returns. From 1926 to 2015, the S&P 500 increased on an annual basis by 9.8%: Dividends were responsible for over 40% of that appreciation. While collecting dividends is not the most exciting/glamorous part of investing, they are one of the most critical drivers to generating long-term returns.
The Importance of Staying the Course
We are currently facing a number of factors that might cause investors to question either their ability or even the wisdom of staying the course. Besides all of the negative headlines out of Europe, we are also approaching a contentious election in the United States. China still remains a concern, and the U.S. stock market continues to march lockstep with the price of oil. It is important to remember the best time to purchase common stocks is during times of uncertainty when share prices are falling. As the late Shelby Davis, an investor who amassed a sizable fortune, once said, “You make most of your money in a bear market. You just don’t realize it at the time.”
While it goes without saying that past performance is no guarantee of future results; history does have a funny way of repeating itself (or as Mark Twain said, at least rhyming). As the chart below demonstrates, in any one-year period since 1965, stocks have increased by as much as 47% in a single year and have decreased by as much as 39%. However, this wide range of investment returns narrowed significantly the longer an investor’s holding period. Over a ten-year time frame, the stock market has advanced by as much as 19% per annum but the worst 10-year period produced a loss of only 1%!
If you look at any 20- year period, the results skew even more in investors favor with the highest average annual return being 17% and the lowest average annual return being a positive 7%! The key to having the best chance of longterm investment success is to have a plan with a strategy you believe in and stick with it through both good times and bad.
Most of our accounts underperformed for the first half of 2016. Our underperformance relative to the S&P 500 can be directly attributable to two factors.
1) The best performing sectors within the S&P 500 were utilities (up 23.4%) and telecommunications (advancing 24.8%) which our clients had minimal exposure to. Utilities are considered “safe stocks” due to their stable earnings and high dividend payouts. However, at the present time, the group currently sells at 22.1x earnings versus a historical average of 15.5x. We believe utility investors are being lulled into a false sense of security and are solely focusing on the sector’s current dividend rate and not the price they are paying to receive that payout. When interest rates rise, enabling investors to receive an adequate yield from government bonds, we think individuals will flee utility stocks en masse (as they are currently investing in utility stocks mainly as a bond substitute). Our only advice: caveat emptor. Remember, future investment returns are not only influenced by picking the right stock, but equally important is the price you pay for it.
2) Financials (down 3%) were the worst performing sector in the S&P 500 further negatively impacting our returns. As we have stated in previous letters, utilizing almost any acceptable valuation methodology, financials have not been this inexpensive since 2008-2009. When interest rates begin to rise (and they will someday, it is just a matter of time) this group has the capability of handsomely rewarding patient investors.
A Look Ahead
While the world continues to be a scary place and we would expect continued market gyrations going forward (especially in the run up to the U.S. presidential election), we are generally bullish about both the U.S. economy and the stock market from a long-term perspective.
Some Reasons to be Bullish
1) The U.S. consumer is in reasonably good shape as household net worth has increased by almost 30% since 2007. According to J.P. Morgan, the average U.S. consumer has seven dollars of assets for every dollar of debt. At some point, he/she will begin to spend greater sums of money further stimulating the economy. In addition, one positive effect of the low yield environment is that households have either refinanced or purchased a new home taking advantage of historically low interest rates. This has resulted in household debt payments as a percentage of disposable income to be at a 35-year low.
2) We believe U.S. housing will be a significant driver of the economy going forward as the current housing supply is low by historical standards. Since the 2008-2009 financial crisis, new home starts have been far below their long-term average of ~1.3 million homes per year. When new homes start to be constructed at a faster rate, this should provide the economy with a further boost.
In addition, in most parts of the country, (with some major exceptions such as New York City, Miami, and San Francisco) housing is still affordable. As the charts below