The Bull Lives
The stock and bond markets both produced gains during the third quarter as investors continue to be optimistic about the U.S. economy. Corporate earnings remain strong and inflation remains low. Both factors combine to produce a good economic environment for the capital markets.
The third quarter was notable for producing two devastating hurricanes, Harvey and Irma. Combined, these two storms caused an estimated $290 billion in damage to Texas and Florida. Lost economic activity is likely much more than this. This is the first time in history that two category 4 or higher hurricanes have hit the U.S. mainland in the same year. One in every seven cars in the Houston area was destroyed by Harvey and 25% of all homes in the Florida Keys were destroyed by Irma. The damage done and the lives affected by these two storms is truly remarkable. We have many clients in both Texas and Florida. Fortunately, all made it through the storms with no physical injuries and relatively minor property damage
Over the years, you have heard a couple of themes from us many times: Stock performance is all about corporate earnings; and economic conditions around the world matter to U.S. investors. To illustrate how the two works together, the latest earnings growth rate for the S&P 500 was slightly more than 10%. Earnings growth for companies with more than 50% of their sales in the U.S. was 8.5%, while earnings growth for companies with less than 50% of their sales in the U.S. was 14.5%. Almost one third of all sales by S&P 500 companies come from non-U.S. markets. A large part of our strong stock market and strong earnings growth is a result of improving economic conditions around the world.
We talked in our last letter about the high valuations we are seeing in the equity markets. That has not changed during the third quarter. An interesting measure of this that is often overlooked is the ratio of household net worth to disposable personal income. Over the past few years, household net worth has risen faster than disposable income. The ratio of the two is at its highest point ever. Like most measures of stock valuations, this metric does not tell us when the market will turn, but it does point to future returns being lower than historical average from current levels.
We continue to be rather cautious in our forecast for the future of this bull market. It is already one of the longest running bull markets since the end of World War 2, and at current valuations, any sign of an economic slowdown could mean a rather severe pullback for the markets.
