Conversations with LVM Capital

We review two of the largest ETF provider classifications for growth and the factors LVM uses for scoring companies based on growth including, five-year sales growth, five-year earnings per share growth, five-year dividend growth, and projected revenue growth for each of the next two-years. 

Tyler and Chuck sit down to review a NAPFA (National Association of Personal Financial Advisors) conference presentation by Bob Morrison attended by Chuck at the fall conference. We pull out and dissect several estate planning mistakes that are made and how to avoid them. 

We start by reviewing the current estate tax exemption (the amount which your estate is not subject to taxes when you die) and its upcoming changes. The federal estate tax exemption for 2022 is $12.06 million, increasing to $12.92 million in 2023 due to its annual adjustment for inflation. These figures are per person, giving a married couple an estate tax exemption of $24.12 million in 2022. The current exemption was doubled under the Tax Cut and Jobs Act (TCJA) and is set to expire in 2026. This means in 2026 the estate tax exemption will fall to an estimated $6.8 million per person or $13.6 million per married couple. 

We follow the estate tax discussion with some estate planning mistakes to avoid including: leaving the wrong assets to charity at death, not considering tax implication of heirs and the type of assets you leave to them, not filing a 706 estate tax return, having accounts misaligned with your estate plan, not updating IRA or life insurance beneficiaries and contingent beneficiaries, not updating your will and trusts after a death or divorce, gifting low cost basis assets before death, not obtaining power of attorney (POA) documents for kids, and not considering the gift annual gift exclusion or direct payments for education or medical purposes. 

Tyler and Craig review the “Value Factor” for our second installment of the fundamental factors of investing. In the investment industry there are various definitions of the value factor, but one description refers to the value factor as the factor that aims to capture excess returns from stocks that have low prices relative to their fundamental value. This is commonly tracked by price to book, price to earnings, dividends, and free cash flow. Historically it is the price to book valuation method that is most often cited for value investing. With low price to book being classified as a value stock. Price to book simply compares the company’s accounting book value or net assets relative to the market capitalization. 

We review how LVM uses the value factor in finding attractive investments including relative valuation methods such as price to earnings and absolute valuations such as the discounted cash flow method.  Craig reviews some common pitfalls investors come across when analyzing the value factor and discusses some of the historical return studies on value versus growth. Tyler reviews current market valuations and compares them to recent historical averages. 

In the first of our four-part series on the fundamental factors of investing, Tyler and Jordan sit down to discuss the “quality factor” and what makes a quality company. Our discussion revolves around operating efficiency, earnings quality, and leverage and capital structure. Keep in mind that the figures we discuss vary by industry, company size, and geography. 

Please see our post for show notes and descriptions: Fundamental Factors of Investing Part 1: What Makes a Quality Company? (lvmcapital.com). 

Tyler and Craig discuss second quarter earnings for the S&P 500 and its constituents which have come in better than expected. Sales were 3% better than Wall Street estimates and earnings were 4.5% better than expectations. Sales and earnings growth were led by the energy sector as earnings in the sector grew by 300% on the backs of higher energy prices. Financials, consumer discretionary, and communication sectors were the only sectors to post earnings declines. Financials were negatively impacted by banks raising loan loss reserves as they prepare for an economic slowdown and the potential for higher loan write offs. Amazon weighed down the consumer discretionary sector with lower earnings, mainly due to a write down of its stock investment in Rivian Automotive. Outside of some weakness in online retail within the sector, consumer spending was strong on travel and entertainment. Spending in the US continues to be strong as evidenced by Disney reporting 70% increases in parks revenue, Starbucks domestic revenue increasing 9%, and American Express credit card spending volumes increasing 25% led by travel and entrainment spending. 

Earnings surprises were rewarded by investors as the average stock reaction to a positive report was a 2.1% increase in the stock price the day after the earnings report. This is better than the average increase of 0.8% over the past 5-years and could be attributed to the market participants getting ahead of themselves with a 25% decline in the market before earnings season started. 

Earnings still look good for the remainder of the year with expectations of 8.9% earnings growth for the full year on 11% revenue growth. The S&P 500 currently trades for 17.5x forward earnings which is below its 5-year average of 18.6x, but above its 10-year average of 17x. That valuation, as Craig notes, is dependent upon earnings meeting the current expectations which have been coming down slightly over the past few months as inflation and the strong dollar are expected to impact company bottom lines. 

Tyler and Jordan recap the first half equity, fixed income, and commodity markets. Inflation is impacting valuations for both stocks and bonds while negatively impacting consumer sentiment. The good news is valuations are coming down to more sustainable levels and returns after bear markets have historically been strong. Check out the charts discussed and a recap of the podcast at Podcast (lvmcapital.com). 

Tyler and Craig sit down to discuss how the current market volatility could be used to one’s advantage. We review rebalancing and having an appropriate asset allocation relative to your goals, objectives, and risk tolerances. Tyler and Craig also discuss the current economic backdrop, the history of market returns after experiencing declines like we are seeing today and how to take advantage tax loss harvesting. Check out our podcast blog post at Podcast (lvmcapital.com) to read a summary and review the charts discussed on the podcast. 

Tyler and Jordan review the Commerce Department’s estimate of first quarter Gross Domestic Product (GDP) which showed the US economy contracted on a real (after inflation) basis. On a current dollar basis, GDP increased 6.5% or $380 billion to a level of $24.4 trillion. The price index for GDP purchases increased 7.8% which brought the nominal growth to negative real growth. Economists estimated the economy would grow at an annual rate of 1.1%, but the first release showed the economy actually contracted by 1.4%. The decrease in real GDP reflected a decrease in private inventory, exports, and government spending. Personal consumption and private business spending partially offset those declines. 

Going back to 1950 the US economy has contracted in 11 different periods. The average peak to trough contraction in the economy is just over 11 months. The shortest contraction was during the 2020 recession which only lasted 2 months peak to trough. The longest peak to trough contraction was during the financial crisis from 2007 to 2009 which lasted 18 months. 

The median S&P 500 return from the peak month of the economic cycle to the trough month is a loss of 11.25% (interestingly, the S&P 500 is down 11.8% since the start of the year). The worst market return during an economic contraction was 35% during the financial crisis. The best return was just over 17% during the post-Korean war recession in 1953. The S&P 500 has returned on average 9.9% annually in the two years leading up the recession with returns nearing 14% two years after the recession ends. The unemployment rate at the start of a recession has averaged 4.7% and climbs to 8.1% at the end of the recession. The current unemployment rate is 3.6%. 

As shown by the decline in the real economy, inflation continues to impact consumers and business. Tyler and Jordan discuss some recent earnings releases in which companies continue to mention inflationary pressures impacting operations. Tyler and Jordan discuss the current strength in consumer balance sheets, income, and spending that could keep the economy from falling into a recession.  

Tyler and Jordan sit down to recap the first quarter 2022 capital market returns. The S&P 500 fell nearly 5% in the quarter with weaker returns in small cap stocks (-7.8%), small cap growth stocks (-12.7%), and large cap growth (-9.2%). The S&P 500 at its low was down 12.4% before staging a rebound in the last few weeks of the quarter. Commodity returns were led by energy which recorded a 46.1% return for the quarter. Strong returns in agricultural products like wheat (+29%) and corn (+26%) were boosted by ongoing geopolitical events. The bond market had its worst quarter in 40 years as the 10-year treasury rose from 1.63% to 2.32% and briefly touched 2.48% before settling lower. As foreshadowed in our last podcast, the 10-year and 2-year treasury curve has now inverted with the 2-year treasury (2.42%) yielding higher than the 10-year treasury (2.35%) as of the time of this taping. The Bloomberg Aggregate Bond Index fell 6% as rates increased due to the Federal Reserve rate hikes and persistent inflation. The labor market remains strong with 1.7 million jobs added in the first three months of the year. The unemployment rate is nearing the pre-pandemic low and now stands at 3.6%. Looking forward to first quarter earnings, current expectations are for revenues in increased 10.7% and earnings to increase 4.8%. 

Tyler and Jordan discuss the recent Fed meeting which resulted in the first interest rate hike since 2018. Fed economists also lowered their projections for economic growth in the US from the 4% projected in January to just under 3%. Economist are warning of slower growth likely due to continued geopolitical concerns and inflation. Tyler discusses the current divergence between consumer confidence levels and consumer spending via retail sales. The US economy is roughly 70% tied to consumer spending so if the poor consumer confidence figures spill over into lower consumer spending the odds of a recession will rise. One historically accurate predictor of a recession is a yield curve inversion. Jordan discusses what to look for and how far away we could be from a yield curve inversion and a potential recession.