The More Things Change, the More They Stay the Same | Denewiler Capital

Observations on the Market //

The More Things Change, the More They Stay the Same

Written by Greg Denewiler, CFA® // October 24, 2022

Let’s go back to middle America, 1961. If you had the skill and time, you could build a three-bedroom, 2-bathroom, and two-car garage on a half-acre lot for $12,000. In September of the same year, you could borrow $10,500 for 20 years at 6%, for a monthly payment of $75.23. You may be thinking – “I wish I had that opportunity.” That was 61 years ago, and we tend to think life was simpler then but was it? The yield on a 10-year treasury was 4% and inflation was 3.8%, on its way much higher. Does this sound a little familiar? If we assume the house was a rental property and an investor bought it with cash – the first year’s rental income would have been around $900 based on the value of the house in 1961. Today, the current rent is $11,900 annually (the house is currently rented out). If we grow the rent by 4.3% a year from $900 to $11,900, we effectively would have earned $265,000 over 61 years. Using Zillow’s current estimate of $160,000 for the house, the investor’s total value would now be $425,000, or a 6% annualized return. However, that doesn’t account for three roofs, being painted multiple times, and having lots of maintenance. Let’s not forget the 61 years of insurance and taxes either. It still would have been a profitable endeavor. What if that same investor decided to invest in Blue Chip America instead?



In September 1961, $12,000 would buy 180 shares of the S&P 500 with the index at a level of 67. The index paid a dividend of $1.96, so the annual income would have been about $360 per year. That rental property sounds much more appealing at this point. Although the dividend income has now grown to $11,700, still short of the rental income, the value of the 180 shares is now $666,000 with the index around 3,700. Using the dividend growth rate of 5.9% (S&P 500 dividend going from $1.96 to $65), the investor will have cashed about $204,000 of checks. That brings the total S&P 500 investment to $870,000. It doubled the total value of the rental property. Real estate does well, but it usually has leverage attached to it, so that can skew the returns to the upside. Compounding the rental income is challenging, so that is why the above example assumed the income was not reinvested. If you go one step further and assume reinvestment of the S&P 500’s dividends, the total value grows to $3,930,000 (no house maintenance required). This is the magic of dividend compounding. There are a few takeaways from this.



It is almost ironic, but interest rates, mortgage rates, and the stock market’s P/E valuation are very similar today to where they were in 1961. The S&P 500’s P/E was 22x in 1961, and it started this year at about 24x. Was life and investing easier back then? One year later there was the Cuban missile crisis. For those of us that were in elementary school in the 60s, you may remember the bomb drills where we had to practice getting under our desks, like that would have helped. We had the protests and race riots of the 60s, and of course the Vietnam war. There was 1970’s inflation and 18% interest rates by 1981. The price of stocks ended the 70’s where they began, except for the dividend income which was positive. There were eight recessions and a near collapse of the economy in 2008. Then there was a pandemic and artificial collapse of the economy in 2020. If you knew what the next 60 years held, you probably would have chosen the house. In the end, the S&P 500 substantially outperformed the rental property. There is a reason why Blue Chip America ultimately wins, and why Warren Buffet suggests you never bet against it.



The simple answer is that corporate America adjusts to the current economic environment and moves forward. The market must eventually beat real estate because middle-class Americans pay their rent or mortgage from the income they earn from working for corporate America. Companies also pay rent from their profits which must be higher than their rent. It is not the other way around. It is as simple as that. There are always exceptions with specific properties just like there are with specific stocks.



Then there is always the current news cycle. In the October 17th edition of Barron’s, Nicholas Jasinski says; “A further cut in the E of P/E would make stocks look pricier, discouraging potential buyers.” The current estimate for earnings this year is $208 (maybe it goes lower), but that puts the S&P 500 P/E at 17x, very close to the 100-year average. If your rental house were to sit vacant for six months, would you accept an offer for 50% less? Apparently, you would if the market earns less for six months.



Investors forget that the odds of corporate America continuing to grow over time are almost 100%, it is just a matter of how long it takes. Historically, it only takes a few years for earnings to recover. Before you assume America has seen its best days, think about this. NASA launched a probe in November of last year on a 100 million-mile, one-year mission to hit the asteroid Dimorphos, which is only 530 feet wide. Dimorphos orbits a larger asteroid every 12 hours, which orbits the sun every 770 days. To call this a moving target is an understatement. The probe was moving at 14,000 mph when it hit the asteroid, but only missed the center by 55.8 ft. You can now sleep at night because the orbit of Dimorphos was changed by 13 minutes, enough to change its path if it was on a collision course with earth. This is what America is capable of accomplishing.


(My father built the house and that was my parents’ mortgage. I came across their old mortgage and that prompted this look back. My sister and I currently rent it out.)


Observations On The Market No.376

About The Author:

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