Another week, another finish higher. This was among the busiest weeks regarding earnings announcements and as with last week, the news was good. For most companies, revenues and more importantly earnings came in better than expected. It should be noted that revenue increases are only modestly coming from organic growth, and more importantly from price increases. While inflation has been moderating, companies continued to raise prices in the second quarter. It will be interesting to see if this holds true in the third quarter. Otherwise, the economy is doing just fine. How much longer companies can increase prices is yet to be seen, but for now, consumers are grudgingly consuming.
In this weekly recap, I tend to focus on the United States since this is not only where we live, but where we primarily invest. However, the question regarding why we are underinvested in international and emerging markets occasionally comes up. The truth is, despite the talking heads insistence on investing abroad, the U.S. has done better, and over most time periods significantly better, than the rest of the world. For comparison sake, the S&P 500 has outperformed Europe YTD (+5.78%), last three years (+25.14), last five years (+54.18%), and last ten years (+148.10%). Naturally, you’re thinking emerging markets must have done better, right? Not so fast. Again, the S&P 500 outperformed YTD (+8.69%), last three years (+45.68%), last five years (+68.66%), and last ten years (+165.49%).
To the outside observer, it may seem that we are being jingoistic, but the numbers don’t lie. The reality is that the United States has certain advantages other countries lack, such as the U.S. Dollar being the world’s reserve currency and more importantly its unending ability to raise its national debt. The argument I often hear for investing abroad is either one of diversification, valuation or the demise of the U.S. Dollar. While on the surface diversification makes sense, the reality is the world is more globally interdependent than at any time in history. Chances are, if the U.S. is doing poorly, so too is the rest of the world. And yes, international stocks are “cheaper” from a valuation perspective, but they’ve been cheaper for more than a decade now. Just because something is cheap, does not mean it will suddenly rebound. History has shown us that. And lastly, the U.S. Dollar may one day fall, most likely due to our debt-to-GDP ratio being unsustainable, but I don’t see that happening anytime soon. Look around. The rest of the world has its own issues and none appear ready to dethrone the United States just yet. We remain open-minded, but for now, the United States remains the best place to invest.
Regarding the U.S., the Federal Reserve once again raised interest rates by 0.25% after taking a pause last month. This hike was widely expected and many believe it will be the last rate hike in this cycle. While the Fed continues to reiterate it could raise rates one more time, it appears unlikely it will follow through barring an unforeseen event. For savers, this is truly a silver lining. For those with emergency savings sitting in cash, or retirees requiring more cash flow, a higher interest rate is akin to free money. For those borrowing, it’s another story and intentional on the part of the Fed. Slowing inflation necessarily means slowing consumption and borrowing. However, despite the rate hikes over the past eighteen months, the economy (GDP) grew at a respectable 2.4% in the second quarter. This was above expectations and signals that while the Fed’s monetary policy has worked in bringing down inflation, it hasn’t crashed the economy. This has led many to now believe we are headed for the magical and rare "soft landing.” At this point, we do not anticipate a recession emerging this year, nor do we expect the Fed to begin cutting rates before year-end. Interest rates will likely stay elevated for longer than anticipated while banks tighten credit standards further.
In closing, I came across an article that caused me to raise my eyebrows. You should know, my wife says my eyebrows are out of control and I can only imagine what they looked like while reading this story. It seems a bipartisan coalition of congressmen are coming after our credit card rewards. Perhaps not directly, but certainly indirectly. In 2010, the Durbin Amendment (part of the Dodd-Frank Act), capped fees that debit cards could charge. It was believed these cost savings would be passed on to consumers, but the Federal Reserve Bank of Richmond found that almost none of the savings were passed on to consumers. In fact, it resulted in the widespread elimination of debit-card reward programs and fewer banks offering free checking accounts. Talk about unintended consequences, the ranks of the unbanked increased by an estimated 1 million people. The current proposal is to expand the Durbin Amendment to include fees credit card companies charge merchants. This effort is primarily being pushed by Walmart and Target, who stand to gain billions of dollars in additional revenue. Many believe that if passed, this will have the same effect on credit card benefits as it did on debit cards over a decade ago. Enjoy your reward points, I know I do, but don’t take them for granted. If this amendment gains momentum, their days may be numbered. Now you know.Bruce J. Mason, MBA