Has the Situation Really Changed?

August 2024 Client Letter

Occasionally, I get anxious before travel. A few of my trips have coincided with some unfortunate crises. In March, several years back, we took a family ski vacation. We’re from Florida and don’t really ski, so heading to Utah was a big deal. Zero problems with the flight, rental car, and accommodations. One snag, however, was that people around the world started getting sick. COVID-19 had begun. As I was starting to settle into mountain life, the stock markets were going bananas, and there were rumors of an economic shutdown. A global dilemma was unfolding, and I was stuck in a ski village. Not cool.

Years after our pandemic vacation, we kept things local and took our first cruise on the Celebrity Beyond. We set sail from Fort Lauderdale, an easy two-hour drive from Naples. Once again, no travel problems. Boarding the ship was a piece of cake, and complimentary champagne was in hand before we set sail. The next morning, I woke up to read that Silicon Valley Bank had failed after a bank run and would be placed under receivership. The third-largest bank failure in U.S. history was underway as I was trapped on a ship with spotty Wi-Fi service. Also, not cool.

This June, we took a trip to Newport, RI. Thankfully, the world cooperated. Stock markets trended higher. A Fed rate cut was not imminent, meaning yields on our money market funds would remain near 5%. U.S. election headlines were relatively tame. No major crisis developed. Very cool and mentally relaxing.
But the tone has changed since we left Rhode Island. The election cycle is in full swing, with significant events occurring in both the Republican and Democrat parties. Expectations for a Fed cut have moved to 100% in the September meeting. Concerns of a U.S. recession have resurfaced. And the stock market has been volatile. For the week ending August 9th, by example, the S&P 500 and the Nasdaq recorded four down-weeks in a row.

Nervous investors are reminded that pullbacks and corrections are normal. A pullback, defined by a decline between -5% and -9.99%, happens on average three to four times a year. A correction, defined by a decline between -10% and -19.99%, happens on average about once a year. Pullbacks and corrections even happen during bull markets. Does that make you feel any better? Me neither. Despite what history tells us, I’m not a fan of seeing red on my account.

But just because I do not like the look of my statement at any given time does not mean I worry. To begin with, stock market volatility is par for the course. You can’t expect to receive a return on investment exceeding the rate of a risk-free U.S. Treasury security and not have risk. With risk comes the potential for reward but also the potential for volatility. No way around it.
More importantly, when volatility happens, it’s good to revisit whether you believe that the economic and investment environment has significantly changed from prior to the onset of the volatility. Let’s look at some indicators for August.

During early August, the labor market slowed, as evidenced in the recent jobs report; but the U.S. economy has still been adding jobs. Full employment is typically considered to be an unemployment rate between 4% and 5%. Unemployment is currently 4.3%. Not a terrible situation.

Second-quarter GDP came in above expectations at 2.8%. Most of the growth was attributed to an increase in consumer spending, which grew at a rate of 2.3%. Given that consumer spending accounts for about 2/3 of our economy, this was welcome news. However, I do not get too excited about consumer spending. Isn’t most of our spending on things we consume regularly regardless of the economy’s health? Mortgage payments, cable and cell phone bills, food, childcare, and utilities are all consistent monthly outlay items for us, no matter where the economy stands. I view healthy consumer spending as a positive, but there are other GDP components that are probably more meaningful such as business investment. 

Business investment is considered a forward-looking economic indicator, reflecting companies’ expectations about future economic conditions. When businesses invest in new equipment, buildings, technology, and other capital goods, it typically signals confidence in future demand and economic growth. Business investment often precedes increases in employment as companies expand capacity and require more labor to operate new facilities and equipment.

The GDP report showed an increase in business investment of 5.2%, with an increase in equipment growing at an 11.6% pace. This is good news. Yes, this is only one quarter of data, and one quarter does not equal a trend. But based on this reading, businesses are not yet acting in a recessionary manner.

How about corporate earnings growth? According to FactSet, as of 8/9/24, for Q2 2024, the blended (year-over-year) earnings growth rate for the S&P 500 is 10.8%. If 10.8% is the actual growth rate for the quarter, it will mark the highest year-over-year earnings growth rate reported by the index since Q4 2021 (31.4%). Forward-looking analysts project earnings growth for Q3 of 5.4%, Q4 of 15.7%, and 14.5% in the first quarter of 2025.

Another item to keep in mind during periods of volatility is the composition of your investment account. The investing universe is broad, with dozens of styles and strategies. Some strategies are high risk, while others are lower risk. Within the equity space, I would consider our strategy to be one of higher quality, which can mean lower risk.

You may recall that we mostly focus on a diversified portfolio of companies that pay dividends and which intend to raise those dividends regularly. Investors typically find comfort in investing in the stocks of big, well-established blue-chip companies that have a record of consistently pay dividends year after year. These companies often have strong financial foundations and stable earnings, which can provide a sense of security even during periods of market volatility. The regular dividend payments serve as a reliable source of income, potentially helping to cushion the impact of market downturns and offering reassurance that the company remains financially healthy. As a result, these stocks can give investors greater confidence to weather more turbulent times in the market.

Almost a King

One of those companies is Automatic Data Processing (ADP). ADP may not be quite the household name as others in your portfolio, but the company is a dividend powerhouse. Founded in 1949 by Henry Taub as a manual payroll-processing service, the company started as Automatic Payrolls, Inc. in Paterson, New Jersey, and later became Automatic Data Processing, Inc., reflecting its expansion into broader data-processing services. ADP is one year away from becoming a “dividend king,” (i.e., with 50 consecutive years of dividend growth).

ADP provides cloud-based human capital management (HCM) solutions. Human capital management is a comprehensive approach to managing an organization’s workforce. ADP is a leader in HCM, with more than 1 million clients in 140 nations. ADP, a Fortune 500 company, is consistently ranked among the top companies in the industry. In recent years, ADP has generated annual revenues exceeding $14 billion, making it one of the largest providers of business outsourcing services globally.

According to ADP, the HCM space is a $150 billion market growing by 5%–6% annually. ADP believes it has unmatched service and expertise and continues to invest in new technologies. At an annual JPMorgan Global Technology, Media, and Communications Conference, ADP referenced its heavy investment in generative AI and other advanced technologies.
ADP has been at the forefront of technological advancements in payroll and HR. It was one of the first companies to offer outsourced payroll services and later introduced online payroll processing, cloud-based HCM solutions, and mobile apps for HR management.

Despite economic fluctuations, ADP has demonstrated resilience by continuing to grow and innovate. Its services are often considered essential for businesses, helping it maintain stability even during challenging economic times.

A Defense Dividend Favorite

L3Harris was formed in 2019 through the merger of L3 Technologies and Harris Corporation, creating one of the largest defense contractors in the United States. L3Harris operates in more than 100 countries and has approximately 50,000 employees worldwide.

Since the merger, the company has engaged in a series of divestitures and acquisitions to create one of NATO’s largest defense contractors with exposure in all key defense segments: space and airborne systems; communication systems; integrated mission systems; and Aerojet Rocketdyne.

The U.S. Department of Defense is one of L3Harris’s largest customers, along with other branches of the U.S. government, allied nations, and commercial clients. The company’s technology is used in various defense systems, including aircraft, ships, satellites, and ground vehicles. L3Harris invests heavily in research and development to maintain its competitive edge. The company focuses on developing innovative solutions in areas such as artificial intelligence, cyber defense, and space exploration. 

L3Harris, with 22 years of dividend growth, has a 10-year dividend growth rate of 14.67%.

SaaS

Software as a Service (SaaS) is a cloud-based software delivery model that has revolutionized how businesses and individuals access and use software.

SaaS applications are hosted on the cloud and accessed over the internet, allowing users to access software from anywhere with an internet connection. This eliminates the need for physical installation and maintenance on local devices. SaaS typically operates on a subscription-based model, where users pay a recurring fee (monthly or annually) to access the software. This model is cost-effective for users, as it reduces the upfront costs associated with purchasing software licenses.

One key advantage of SaaS is that updates and new features are automatically rolled out by the service provider without requiring any action from the user. This ensures that users always have access to the latest version of the software.

SaaS solutions are highly scalable, making it easy for businesses to adjust their usage based on their needs. Whether a company is growing or downsizing, it can scale its SaaS subscriptions up or down.

SaaS and Oracle

Oracle Corporation is one of the world’s largest and most influential technology companies, known for its database software, cloud solutions, and enterprise software products.
Oracle offers one of the most comprehensive SaaS portfolios in the market, covering various business functions. Its cloud applications are integrated, allowing businesses to connect their data and processes across different departments seamlessly.

Oracle has integrated artificial intelligence (AI) and machine-learning capabilities into its SaaS applications, offering features like predictive analytics, personalized user experiences, and automated workflows to enhance productivity and decision-making.

Oracle’s product portfolio spans databases, enterprise resource planning (ERP) software, customer relationship management (CRM) systems, supply chain management (SCM) solutions, HCM software, and more.

Oracle, with 13 years of dividend growth, has a 10-year dividend growth rate of 20.27%.

The Trump Trade vs. the Harris Trade

In speaking with many of you, I know the U.S. election cycle is a source of stress and fatigue. The constant barrage of campaign ads (now being texted to me, which is very annoying), debates, and political commentary can wear down even the most engaged individual. Moreover, dissatisfaction with the available candidates often leads to a sense of disillusionment, where voters feel forced to choose between the lesser of two evils. As a result, many have opted to distance themselves from the political process, avoiding political television and reading less about politics than they used to. Compounding this is the realization that much of what is promised on the campaign trail often fails to materialize into actual policy, further deepening cynicism and disengagement.

Personally, I spend little time getting into the weeds of the current campaign yak. When campaigning, the candidate has only one goal. To get elected. This means maximizing votes in swing states such as Arizona, Georgia, Michigan, Nevada, Pennsylvania, and Wisconsin and addressing the most pressing issues in those states. It’s a hustle to get 270 electoral votes, so the process has become a gigantic marketing blitz.

So, how do we handle the election season and the upcoming inauguration as it relates to our investment portfolio and outlook on the markets and the U.S. economy? I try to have a broad perspective and concentrate on a handful of factors.

1. Limited presidential power: The president does not have unilateral control over economic policy. The U.S. government operates with a system of checks and balances, which includes the legislative branch (Congress). If the president’s party does not control both the House and the Senate, passing major economic reforms or policies can be difficult. This often leads to compromises or gridlock, which is what we have had this year and last.

2. Policy uncertainty: Even when a president does have party control of Congress, proposed policies often undergo significant negotiation and changes before they are implemented. Initial reactions to campaign promises or proposals can be exaggerated, as the final versions of policies may be different from what was originally proposed. This means that market fears or optimism based on campaign rhetoric can be misplaced. By example, Barack Obama campaigned on the idea of rolling back the George W. Bush tax cuts only to then make most of them permanent when president. Or, how about candidate George H. W. Bush proclaiming, “Read my lips: no new taxes.” Once in office, “no new taxes” became “new taxes,” contributing to him being a one-term president.

3. Market resilience: Historically, the stock market has shown resilience regardless of which party holds the presidency. Markets are influenced by a wide array of factors beyond presidential policies, including global economic conditions, interest rates, corporate earnings, technological innovation, and consumer behavior. The stock market tends to adapt and find equilibrium over time, regardless of the political environment.

4. Long-term focus: Always a helpful mindset. I encourage you to maintain a long-term perspective rather than reacting to short-term political events. Market volatility around elections is typically short-lived and, over the long term, market performance is more closely tied to economic fundamentals than to the specific party in power.

5. Diversification of influence: Many factors affecting the stock market are outside of the president’s control. Global economic trends, geopolitical events, central bank policies, and technological advancements often have a more significant and immediate impact on the markets than do domestic political outcomes.

While presidential elections can introduce uncertainty and short-term volatility, the long-term impact on the stock market is usually less pronounced than many fear. Obviously, the compounding of bad political policies can significantly damage our economy and standard of living. However, as far as the balance of 2024 and the beginning of 2025 is concerned, I don’t think the economy will fall off the cliff. Once the elections are over and we see how our government is organized, and we’ve collected another four months of economic data, then we can begin to assess how next year may play out.

Have a good month. As always, please call us at (800) 843-7273 if your financial situation has changed or if you have questions about your investment portfolio.

Warm regards,

 

 

 

Matthew A. Young
President and Chief Executive Officer

P.S. Royal Caribbean recently announced the next three months have more cabins booked than normal and the company is making more money because people are willing to pay higher prices. During an earnings call, Royal Caribbean CEO Jason Liberty said, “All the yield improvement that you’re seeing in Q3 and Q4 is really being driven by price. I think it’s a really strong indication that [sic] not only the willingness to pay more, but these prices continue to increase as we build and manage demand.” The cruise industry is not considered an economic bellwether, but as we have seen over the last several years, the consumer appears to have confidence in their financial situation.

P.P.S. Pig Butchering Online Scams Are Proliferating. Here’s Why They Work So Well. The WSJ interviewed cybersecurity experts on an online scam in the form of text messages. Always good to be vigilant on these issues, either for yourself or a family member. The gist of the scam is that fraudsters look to establish some type of relationship with a victim by sending an initial text. If the victim does not recognize the number, he may respond with, “You have the wrong number.” The scammer texts back, apologizing, and sends more texts trying to establish a dialog. The end goal is to gain access to the victim’s money, which, believe it or not, they are able to do in some instances. As the article notes,

“Until a collective strategy is put together, you need to be aware of the red flags. And the first one is unsolicited contact. We’ve all gotten that text message, ‘hi.’ That message has a fundamentally different feeling to somebody who is elderly and widowed and lonely. When they see ‘hi,’ that has a profound impact on them. If you get an unsolicited contact, ask questions. If they want you to invest in cryptocurrency, do a little research on the site.”

P.P.P.S. Quote of the month: “October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” – Mark Twain