Back to Quarterly Letters

Back to Quarterly Letters || Previous Letter || Next Letter

Quarterly Letter to Clients

October, 2023

Indices at quarter-end (September 30, 2023):

Dow Jones Industrials: 33,507.50 3Q'23 -2.62% YTD +1.08%

Standard & Poor's 500: 4,208.05 3Q'23 -3.65% YTD +11.68%

Fifty-five years ago, in my Econ 101 class, the professor posed this question: If a company’s charter prohibited it from paying dividends, what would be the value of the company’s stock? Everyone was a little perplexed, as there seemed to be too little information to put a price on a stock, and we were all young and naïve.

The answer was zero. If a stock could never pay a dividend, there would be no way for a purchaser to participate in the earnings of the company, and thus no market for it.

Now, there are plenty of stocks out there that do not pay a dividend, and some are growing revenues (if not earnings) smartly and seeing their share price climb. But there is always the long-range hope that they become mature, income generating companies, while continuing to grow.

My econ prof didn’t talk much about bonds; I can forgive him, after all, he was addressing 19- and 20-year olds. I had to learn the fundamentals later, in a class at Hayden Stone.

To be a buyer of bonds, you need to believe certain things. You need to believe that interest rates are not going substantially higher; you need to believe that inflation will not be a significant factor; you need to believe that the issue you are buying will pay the interest and principal.

Your goal is to protect your money, and to reap a reasonable income that might keep up with inflation. You expect only minor fluctuations in your account values.

To be a buyer of stocks you need to believe all of those same factors. In addition, you need to believe that the stocks you buy will increase their earnings and thus their market price; and you need to believe that dividends will eventually be paid, even if that thought is not top of mind.

Your goal is to grow your money, at some number of percentage points above inflation. You expect fluctuations, and you prepare yourself emotionally.

At the moment, I believe that inflation, while moderating, is still too high for the members of the Fed to relax. I believe that will keep rates higher longer than most observers would like. I feel that a decline in rates is not something that will happen any time soon. Thus, my bond purchases are limited to very short-term issues from the highest quality issuers. I also believe that the economy is still strong, and that earnings estimates will continue to rise; but that stocks are likely to be sluggish until inflation is seen as stable.

It is not far-fetched to think that inflation will, over time, lift the prices of equities. It is generally thought that stocks will gyrate more radically than bonds, and so a mixture of the two asset classes should result in a smoother ride. We expect that stocks will, over the longer run, outperform bonds, but we further know that over any given period expectations are nothing more than hope.

We know that in the face of inflation and higher rates bonds will underperform. The question is, how will stocks react in such an environment? Historically, such periods have meant weaker equity prices. Over time, of course, companies adapt; it is for the near term, the next year or two, that the question is important.

Inflation remains stubborn. We need to own equities to (hopefully) help us in that area. And we need to be prepared to wait. As always, time is the biggest friend of the investor.

Jim Pappas