Moneybeat: A period of volatility

MARY REICHARD, HOST: Coming up next on The World and Everything in It: the Monday Moneybeat.

NICK EICHER, HOST: All right, it's time now to talk business, markets, and the economy with financial analyst and advisor David Bahnsen. David is head of the wealth management firm, the Bahnsen Group, and he is here now. David, good morning.

DAVID BAHNSEN: Well, good morning, Nick. Good to be with you.

EICHER: Hey, well first, welcome to World Opinions, David! I'm glad to hear that, that you'll be writing for us each week.

BAHNSEN: Yes, it was a lot of fun to be joining that fray. The article that just came out, I'm kind of addressing the subject of inflation in really a way we've talked about it here on the podcast many times. The different nuances that go into things, what had the kind of history of inflation has been over the last several decades and what put upward pressure on it in times past, and then what put downward pressure on it. And then the unique circumstances out of COVID in the last couple of years, and really where we stand now, what governments and central banks can do to make things worse. So that was the theme of that article, kind of a high level, and I think very nonpartisan attempt to understand the subject better.

But on a go-forward basis, something that will address the economy and finance at large in a way that is thoughtful. I would like to introduce some of those economic concepts that are first principles and apply them to the different issues that come up week by week. I think a lot of us—and you know I speak to myself here as well—we have a tendency to see an issue that comes up in the news and immediately interpreted according to, you know, certain instinct. And I like those instincts when it comes to economics to be rooted in first principles, connected to a biblical worldview. And that's going to be the general theme of that weekly writing.

EICHER: Yeah, that's great. I'll put up a link to all of your WORLD stuff in today's program transcript. But moving right along here, David, we have not talked about the stock market in a good little while. It appears we're now in a period of volatility. What are your thoughts on that?

BAHNSEN: Well, it's interesting, where we sit now getting to the later portion of the month of April, is that the markets did very well through the first quarter, and then really just started off in the month of April, to the downside. And in the first couple of weeks, the market had dropped 3-4%, depending on the index. And now we kind of, you know, come into this new week here on this Monday, and we'll see where things go.

But, you know, more than just I think the very recent volatility, the bigger point I'd make is that the S&P 500 is trading at a valuation about 22 times forward earnings. And the market has historically traded at about 16 times earnings. And at this point, when it's this expensive, the stock market is vulnerable to sell offs when earnings disappoint, or when there's geopolitical aggravation, or when there is unexpected things from the Fed and so forth. I don't mind the noise, you know, I don't mind volatility. But I do think people have to be careful when you're talking about something that is expensive. One of the biggest factors in a long term return for an index will be the entry point. And when you enter at an overly expensive point, it can really take away from the long term expected return.

And so I am very, very bullish on individual companies and bullish on individual opportunities. But I think people have to realize the S&P 500 right now has become about 10 companies more or less, because of the way it's weighted. Ten companies represent about 30% of the index, and 490 companies represent the rest. And there is such an extremely expensive valuation on a big portion of that top heavy stuff that it's it's, I think, going to have an impact on markets. And a lot of what we call a range bound market, where you may be up a certain amount one year down a certain amount the next but over 5-6-7 years, doesn't move a ton. And that is historically what has happened every single time for 100 years that we have left a secular long-term bull market. When we've had a you know 10 to 15 year period of rising stocks, you generally get a multi-year period of flat, choppy, range bound market. That's the period I believe we're in now. One of the reasons that I'm so focused on dividend growth, companies individually growing the dividends. Those dividends become a vital part of return in a market like this.

EICHER: All right, gross domestic product for the first quarter GDP. It's due out this week. Any thought on how that will end up looking?

BAHNSEN: Well, all the revisions to GDP in the United States as of late have been upward revisions. Forward, you know, I think most people are aware that there's a lot of indicators that are sort of frozen. You know, manufacturing has had a couple good reports lately, but that was after 14 or so months in a row of negative activity manufacturing. So that would be interesting to see if that can get a little more consistent and at least be in some positive expansion.

We talk on this podcast all the time about the jobs data, and I think that we're all well aware that what the different tension points are in the jobs data. A good amount of people are employed who want a job, but a still high amount of people are not looking for work. And that's a long term trend that is pretty embedded in the culture right now. And I think productivity is the big issue. You know, there are certain policies that have passed that I don't agree with, but nevertheless, could have a chance of impacting productivity.

But then even apart from anything in the public policy sphere, you know, we've had downward pressure on productivity for a long time, and there's been signs of life there. And so I'm hopeful that at least in the short-to-intermediate term, there could be a pickup, but it's all work in progress, and this GDP coming this coming Friday is going to be very interesting, because, you know, if you think about it, Nick, there are indicators that people know to look for, like the employment report, the CPI, where the inflation side is. But then you're supposed to kind of get a summary of it all. Like, okay, get validation for how things are going in the GDP. And what's interesting is the GDP, that kind of sum, the net sum of the output, has been pretty good for the last couple quarters. And yet, I haven't really seen a lot of people that are feeling it's going better. They have forward-looking indicators that try to estimate. The Atlanta Fed tracker is the most well known. And it's notoriously off. I mean, it can be up or down quite a bit. So I wouldn't view it as a super reliable indicator, but it's been more accurate lately. They're estimating 2.9% real GDP growth, annualized coming in this next quarter. So we'll see how that holds up.

EICHER: Okay. And “Defining Terms” for this week, David, I'd like to go back to your discussion on stocks. And what you said today, I have heard you say a form of on Fox Business and CNBC, that a lot of stocks are just overvalued. They're too expensive. Could you talk a little bit about how you even come to those conclusions? I mean, how do you figure stock valuations? We hear the term thrown around quite a bit.

BAHNSEN: Valuation is an extremely important component of how we think about stocks. And the way I would summarize it is like this: if a company is trading at 20 times earnings, what that means is that if the company gave you all the earnings, all the profits for 20 years, that's when you'd get your money back. Now, of course, they're not going to give you all the profits. But also, hopefully, the profit level is growing year by year. So it doesn't mean it would take 20 years, but at the current level of profits, it would take 20 years to get your money back, if you were getting all the profits. So nobody really thinks that's a good investment to wait 20 years to get their money back. So they're hoping profits will grow a lot. But then again, the other component is what level of the profits you're getting back.

When I talk about something being expensive or cheap, all you can do is look at what historical averages have been. There's a concept called reversion to the mean, that you're going to get back to—one way or the other—sort of historical level at which something has traded. And we use price to earnings as a very common valuation metric, because stocks ultimately that's all they are, is a discounted value brought into the present of future expected earnings. That's why people buy stocks. They paid today to get a right to future earnings. But of course, there's other components that go into earnings, Nick. There's the revenues that a company generates. So we can look at price to sales. There's the assets that a company has. You know, there's companies we own, that one of the most attractive things about it are the assets that they have the real estate, the intellectual property, the inventory, the brand name, and so you can look at what's called a price to assets ratio or a price to book value, what the kind of value of the company is relative the price. That famously is a metric that Benjamin Graham, the great value investor who taught Warren Buffett, used. So you have to look at all these metrics. And yes, they all come down to valuation, trying to look at whether or not a stock is cheap or fairly valued or expensive. And yet, even from there, I just want to make sure everyone understands, expensive stocks can get more expensive. They can stay more expensive. Theap stocks can get cheaper and stay cheap. So it doesn't tell you anything about the next price movement. It is not a timing indicator. But like I said, valuation matters a lot for long term results.

EICHER: Okay, David Bahnsen, founder, managing partner and chief investment officer of the Bahnsen Group. You can check out David's latest book, it's titled Full Time: Work and the Meaning of Life at fulltimebook.com. Have a great week, David.

BAHNSEN: Thanks so much, Nick.

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