The Inevitable | Denewiler Capital

Observations on the Market //

The Inevitable

Written by Greg Denewiler, CFA® // January 26, 2023

Some investors think it’s inevitable we are going to have a recession, or that the Fed will bring inflation under control. Others have the opinion that oil prices must inevitably go lower, while some think that due to lack of exploration, they can only stay elevated. It only seems inevitable that higher interest rates will continue to put pressure on stock prices. In case you have forgotten, the definition of inevitable is: certain to happen, unavoidable. When it relates to investing, is anything really inevitable? Here are some of the things that seemed inevitable in the last few years.



Let’s start with the events of 2020. In February of that year, the market reacted pretty much exactly the way you would expect if the world’s economy was shut down. It initially fell, and by a lot. What wasn’t inevitable was what happened afterward, stock prices ended 2020 at all-time highs. With massive central bank intervention, of course, it was inevitable that they would rebound. It was also obvious that oil prices would go much lower because no one was driving, and it seemed impossible that they would ever fully recover. The economy had changed, and people would continue to drive less. However, the price of oil would recover, partly because drilling never returned to pre-pandemic levels. Now it seems inevitable that drilling for oil is permanently suppressed because it will remain a very politically charged topic.



Investors usually expect higher interest rates to put some pressure on corporate earnings and stock prices, which is a reasonable assumption and is exactly what happened. At the beginning of last year, S&P 500 earnings were projected to end 2022 at $225. They finished the year roughly 10% lower at around $200. The easy connection would be to also assume that dividends would not have grown by much either, if at all. Contrary to the obvious, the dividend finished 2022 up 11%, which is well above its long-term growth rate. Not as inevitable as the earnings decline would suggest.



Anderson Cooper is the son of Gloria Vanderbilt, who is the great-great-granddaughter of Cornelius Vanderbilt. If you assume 3% inflation, Vanderbilt’s fortune is worth $7.5 billion in today’s dollars. He died in 1877 with an estimated net worth of $100,000,000. There are much larger individual fortunes today, however, you would assume that $7.5 billion would last more than three generations. It would seem inevitable, and that is precisely how the heirs of the Vanderbilt fortune lived. Somewhat surprisingly, Anderson Cooper has said that he expects to inherit little if anything from his mom. Fortunately for Anderson, he did not adopt his former generation’s mindset and has created his own legacy. Mindset impacts everything.



In Behavioral Finance, predicting the future with near-term experiences is called recency bias. Wikipedia describes this tendency as: a cognitive bias that favors recent events over historic ones; a memory bias. This is a problem that investors face, and it affects most investors. It is easy to see why recency bias is so powerful — we all only live in the present and are uncomfortable admitting we don’t know how the future will unfold. It is difficult to know daily, let alone the next month or year. However, there are just too many variables at play, and when you throw money into the equation it almost forces us to have an opinion. Our daily account values can have an impact on our lifestyle or how we define ourselves. It then becomes very easy to jump to what seems inevitable. In life and investing, very few outcomes are truly inevitable, but some do come close. The economy exhibits a couple of these factors.



As we enter 2023 there are so many outcomes that seem inevitable. This is a great time to step back and reflect upon what really is as close to inevitable as you can get, or at least what has been historically. Nominal GDP grows by about 6% per year on average and has remained relatively steady for over 100 years. Earnings of the S&P 500 are more volatile but have also grown by about 6% per year over the same time frame. You get one guess as to how fast dividends have grown on average in the same period. This leaves you with a decision to make as an investor: are you going to invest based on your perception of what you think is inevitable this year? Or are you going to focus on what has been inevitable and extremely predictable for the last 100 years — that the economy eventually grows. Cash flow and compounding do inevitably lead to wealth, and dividends are one way to get you there. Earnings declined this year while dividends did not. Investors should always be careful assuming anything is inevitable.


Observations On The Market No.379

About The Author:

Greg Denewiler, CFA®
Owner & Chief Investment Advisor at Denewiler Capital Management