Most of the major U.S. stock market indices ended October at or near all-time highs. The bull market that began in March of 2009 continues, accompanied by the typical and inevitable pullbacks and corrections. Its end will come either when stocks get too expensive relative to bonds or when earnings decline, neither of which is the case now. Since 1937, the US stock market has gone up in approximately 77% of the years because the US economy grows most of the time and the value of companies with strong business models increases. Still, many investors try to guess the 23% of the time stocks decline, or even worse try to time, to no avail, the quarterly up and down moves in the market. Most of the returns in stocks are concentrated in sharp bursts beginning in periods of great pessimism or fear, as we saw most recently in the 2020 pandemic decline. We believe time, not timing, is key to building wealth in the stock market. People are impressed with real estate returns because it's typically the only asset that people hold long enough to experience compounding. Anecdotally, everyone knows someone who paid $150,000 in 1995 that is now worth $300,000. That’s a 2.7% compound annual growth rate. Even compounding at a low rate is rather impressive.
Of course, there are always things to worry about for stock investors. Our worries won’t have any impact except to detract from something much more useful, which is trying to make good long-term investment decisions. Today’s worries include, but are not limited to, inflation or stagflation, high and rising fuel and food prices, labor shortages, disrupted supply chains, the impact of those factors on corporate profit margins in the 4th quarter and 2022, China’s regulatory actions, the effect of Federal Reserve tapering, potential default due to the debt limit standoff and the ongoing dis-function and polarization in Washington. These are legitimate and well-known concerns and are likely adequately reflected in the market. After being involved in the investment business for over 40 years, one thing we are fairly confident of is that twelve months from now many of those worries will have been replaced by a new set of worries.
In the meantime, earnings remain exceptionally strong. With over half of the S&P 500 companies having reported third quarter results thus far, revenues are 16% higher and earnings are up 36% (10% higher than consensus expectations) from a year ago. It is remarkable, and a testament to good management, how well Corporate America did in the third quarter, despite the spike in Covid-19 and huge supply chain issues. Most encouragingly, demand remained strong.
As in most markets, there are areas of over-valuation and under-valuation, with the bulk of shares appearing to hover around fair value relative to their prospects. We, of course, continue to focus on securities where the opportunities for long term excess returns appear greatest. We believe balance sheet quality is even more important than normal and our focus is on companies with low debt/equity ratios and high liquidity ratios and high returns on capital. Additionally, we like sectors or companies with these micro characteristics: low fixed costs, high variable cost, high barriers to entry or oligopolistic features, demand inelasticity and pricing flexibility.
As we approach Veteran’s Day, we extend our deep appreciation to all those who have served and to their families. We remember and honor those who made the supreme sacrifice so we can enjoy the freedoms we do today.