History doesn’t repeat, but maybe it rhymes
In this week’s video insight Roger shares reasons to be optimistic about investing in equities and current market conditions. Despite all the doom and gloom surrounding markets at the moment, what matters more than anything else is inflation. Inflation hurts stocks overall because consumer spending drops and corporate profits are impacted by higher input costs.
Hi, I’m Roger Montgomery from Montgomery Investment Management, and welcome to this week’s video insight. Well, the chatter continues about whether we’re going to have a hard landing, a soft landing, and there’s even some talk now about no landing at all. The economy just continues to plot on growing at arguably anemic rates, but avoids a recession, and that’s certainly a possibility. But does it matter? Well, no. In fact, what matters more than anything else is inflation. And as long as inflation is coming down, that’s disinflation, that tends to be good for equities, particularly growth equities or innovative companies, and that’s certainly the case when we have disinflation as well as some economic growth.
All of the talk about the state of the economy is really just a distraction. It’s more important that you start thinking about whether or not a lot of the talk about whether we’re going to have a recession is a legacy fear from the volatility of last year.
Now, Benoit Mandelbrot noticed many, many years ago that there were changes in the nature of volatility in markets. He observed that markets have long periods of low volatility interspersed by brief periods of heightened volatility. 2022 was certainly a period of heightened volatility. The legacy of that volatility is that we’re still talking about possible crashes and corrections in the market now, but if we’ve left that brief period of heightened volatility and entered a much longer period of more stable volatility, then eventually what will happen is investors will focus on what matters, earnings growth and the quality of the underlying business. And on that front, let’s just talk a little bit about earnings growth.
We know, and we’ve said this many times here on the blog and on our videos, that if you can buy a company and sell a company’s shares for the same P/E ratio, your return will equal the earnings growth rate. That presses upon you the importance of finding businesses that are growing at double-digit rates.
Because even if stocks don’t become more popular, you’ll still end up with a double-digit return provided you buy and sell the shares on the same P/E ratio. And that’s what I think investors should now be focusing on. Focusing on what’s important, earnings growth and the quality of the underlying business. Don’t worry about economic growth, don’t worry about unemployment and those other factors that can distract. Instead, now focus your attention on the quality of the underlying business and also on the growth rate of its earnings.
And finally, let me give you two reasons why I’m optimistic about this year.
First, when poor years occur in the past, they’ve tended to occur in isolation. They tend not to cluster. In fact, going back a hundred years, there’s only one period where there were four negative years in a row, and that was during the Great Depression. There was only one period where we had three negative years in a row and one period where we had two negative years in a row. The rest of the time, negative years tend to occur in isolation. Last year could be one of those years.
Secondly, we also know that poor years tend to be followed by good years. And in fact recently, I conducted some research on this and found that when the market fell by more than 20 per cent, the following year was more often than not, with the exception of perhaps two occasions in the last 150 odd years, the next year tended to be a good year as well.
So there’s two reasons why I think we have reason to be optimistic. History doesn’t repeat, but maybe it rhymes.