May 2023 Client Letter

Several years ago, when my family was considering taking our first cruise, many of you encouraged me to set sail, promising I would not be disappointed. We started research on various cruise lines and destinations and were ready to make our deposit. Then COVID hit, closing the cruise industry for most of 2020 and half of 2021 and leading to disappointment for a lot of us.

In March we regrouped and made the short drive from Naples, FL, to Port Everglades in Fort Lauderdale and boarded Celebrity Beyond. For this trip we conducted zero research; we simply signed up for the exact cruise that friends of ours recently made.

Upon boarding the ship, I learned several things. The first was that the Beyond was a new ship with its official debut in April 2022. The second was that our cruise would be the first full-capacity voyage for the Beyond. This was terrific news to the ship’s crew after suffering through the pandemic pause. According to Cruise Lines International Association’s 2023 report, cruise tourism is expected to reach 106% of the 2019 level this year. The cruise industry continues to be one of the fastest-growing tourism sectors, jumping from 29.7 million in 2019 to a predicted 36 million by 2024 and 39.5 million by 2027. Norwegian Cruise Lines is calling it the “Great Cruise Comeback.”

Hoping for a Comeback in Bond Yields

After more than a decade of ultra-low interest rates, many investors have been hoping for a great comeback in bond yields. Bonds have long served as a counterbalance for conservative investors and those in or nearing retirement. Investors looking to maintain a prudent risk/reward strategy tend to appreciate the reduced volatility that has historically come from including a fixed income component in their portfolios. Bonds have historically provided ballast even when rates were low, but the ultra-low level of yields for the last decade has made bond investing more challenging.

Fortunately, the past year has seen a significant increase in short-term interest rates, including those earned on cash sitting in your money market. The yield on your Fidelity Treasury money market is over 4.5% today—the highest it has been since 2007. Treasury bills are also offering their highest yield in over 15 years. Three-month T-bills currently yield 5.15%.

For short-term maturities, the yield comeback has been in full swing. Unfortunately, intermediate and longer-term yields haven’t increased as much as short-term yields. Five and 10-year Treasuries yield 3.45% and 3.43%, respectively. Short-term Treasuries are influenced primarily by short-term interest rates, which are set by the Federal Reserve. Long-term rates are influenced more by inflation and economic growth.

A good back-of-the-envelope guide to a fair yield for long-term Treasuries is the rate of nominal economic growth. This century, nominal G.D.P. growth has averaged 4.4%. Over the last year, nominal G.D.P. has increased by 7%. By this metric, the 3.43% 10-year Treasury yield is still too low.

Of course, the stage of the business cycle, supply and demand factors, and many other issues can influence bond yields and their appeal at any given point in time. What factors might push longer-term interest rates higher? A resolution of issues we are seeing in the banking system, faster growth, inflation that turns out to be stickier than is currently anticipated, or perhaps a change in the market’s assessment of the additional yield needed to invest in longer-term Treasury bonds. Historically, long-term Treasuries offered additional yield as compensation for taking on the additional risk in long-term bonds. In recent years, that premium has disappeared.

In the meantime, we continue to hunt around for corporate bonds. For example, we recently purchased an A-rated, 5-year Medtronic bond. Medtronic is a leading medical devices company. Medtronic invented the first wearable pacemaker in 1957. Recently Medtronic received F.D.A. approval for its Micra AV2 and Micra VR2 pacemakers. The AV2 and VR2 are the world’s smallest pacemakers. With approximately 40% more battery life compared to previous generations, the AV2 and VR2 are expected to last an average of 16 and 17 years, respectively.

Re-investment Risk

With more attractive yields on short-term bonds, some investors are inclined to focus exclusively on these issues. While buying the shortest maturity bills and notes can be a sound strategy under certain circumstances, it is not without risk. The risk many investors focus on when purchasing Treasuries is duration risk, but re-investment risk may be just as important today. Re-investment risk is the risk that maturing short-term bills and notes will have to be re-invested at lower rates if interest rates decline. For example, if the Fed pivots and begins cutting rates, it is possible that short-term interest rates will drop below the level of today’s intermediate-term bond yields. Investors who purchased short-term T-bills would end up missing out on higher yields on longer-maturity issues.

The Treasury maturities we favor change with the level of interest rates, the shape of the yield curve, and our outlook for the business cycle. Today we are purchasing bonds that mature in approximately one year, two years, five years, and seven years. The shorter-term maturities offer higher yields, while the longer bonds provide some protection from re-investment risk should rates fall. Prior to the collapse of Silicon Valley Bank, we were targeting maturities out to 10 years. Rates fell quickly following the bank’s collapse, and we have shifted our maturities as a result.

A “set it and forget it” strategy doesn’t work for bonds. Our fixed-income strategy evolves with the credit cycle, the business cycle, the economic cycle, and the level of interest rates and credit spreads. A few months into the recovery from COVID we owned almost no Treasury securities and were investing in below-investment-grade high-yield bonds and floating-rate notes. Last year, we exited below-investment-grade fixed-income securities and boosted our allocation to Treasury securities, focusing on short maturities first and, more recently, extending maturities.

The changes we make to fixed-income portfolios aren’t designed to predict interest rates, economic growth, or the business cycle. We are simply aligning portfolios with what we believe are the most favorable risk/reward trade-offs prevailing in the market. In poker terms, we’re playing our best hand with the cards dealt. We aren’t trying to predict the next card to come out of the deck.

One Year Later, I Bonds Lose Some Appeal 

A year ago, Series I savings bonds (I bonds) were receiving lots of attention. I bonds are U.S. savings bonds carrying a floating interest rate that rises and falls with the Consumer Price Index. The interest rate resets every May and November. Last May the rate hit a juicy 9.62%. That rate reset in November to a still-attractive 6.9%. Now the May reset has lowered the rate to 4.3%.

According to Bloomberg.com:

Because of the twice-yearly resets, the date investors purchase their I bonds can make a big difference to their returns. Bonds purchased before the end of April will provide six months of the prevailing rate of 6.89%. Then, six months from their purchase date, they’ll take on the 4.3% rate for the subsequent six months. But someone who waits now will take on the 4.3% rate for six months and then the still-unknown rate, to be set Nov. 1, for the following six months.

I bonds are not the worst purchase an investor could make, but they do come with some notable drawbacks. There is a maximum purchase amount of $10,000 annually using cash, and $15,000 if you use a portion of your tax refund. I bonds earn interest for 30 years unless you cash them in first. You can cash them in after one year; but if you cash them in before five years, you lose the previous three months of interest. I bonds also must be purchased directly from the Treasury website or via your tax return.

Does De-Dollarization Threaten My Financial Security?

I am frequently asked about the threats posed by de-dollarization. If you are not familiar, de-dollarization refers to foreign countries reducing their reliance on the U.S. dollar as a means of exchange and a store of value in international trade and financial transactions. This can be done by diversifying foreign currency reserves, promoting the use of other currencies in international trade, and establishing alternative payment systems that bypass the U.S. dollar.

The loss of reserve currency status is a perennial favorite topic of some in the financial press and in certain corners of the internet. The implications of a loss of reserve currency status sound frightening. Soaring borrowing costs, a plunging U.S. dollar, excessive inflation, a diminished role for the U.S. on the world stage, and turmoil in financial markets are cited as potential outcomes if the world were too de-dollarize.

When foreign governments take steps to reduce their reliance on the U.S. dollar, the predictions of doom sound like they may be coming true. China and Brazil recently agreed to settle trade in their own currencies. And Russia has been settling trade directly with China since the West cut it off from the SWIFT system in retaliation for invading Ukraine.

The U.S. weaponizing the dollar probably doesn’t make many countries sanguine about continuing to rely on our currency; nor does soaring federal debt and deficits, but the fact is the dollar’s looming demise is most likely exaggerated. For starters, the dollar is not the world’s reserve currency. It is a reserve currency. And the dollar’s share in the world currency reserve basket has been falling for over 20 years with almost no impact on the economy, interest rates, the U.S. dollar, or the USA’s geopolitical influence. The chart below shows that, in 1999, dollars were 72% of allocated currency reserves. Today that figure is 58%. The Chinese renminbi’s share of total world currency reserves is 2.7%.

Why don’t more foreign governments purchase yuan in their currency reserve basket? There are likely many reasons. Two that come to my mind are 1) China being a single-party system that may have some inherent stability risk, and 2) China’s capital account being closed. Funds can’t come and go at will from China like they can in the United States.

The U.S. dollar is the world’s primary reserve currency because the United States is the world’s largest economy; it has the deepest and most liquid capital markets; it has a freely floating exchange rate and an extremely competitive economy and commercial sector, a well-established rule of law, property rights, and a constitution that limits the potential for significant change at will by a small majority. If you are a smaller country reserve manager entrusted with preserving a rainy-day fund meant to stabilize your country’s currency in the event of economic turmoil, will you buy Chinese yuan, Brazilian real, Russian rubles, Indian rupee? Or will you buy the U.S. dollar?

Even if you don’t buy my reasoning on why the dollar will remain the primary reserve currency for years to come, walk through the implications of some of the more ominous outcomes cited by the dollar doomers. Take a hypothetical example of the dollar taking a steep dive because all foreign governments simultaneously decided to rush out of U.S. dollars. (Very unlikely, but still a useful thought exercise.) If the U.S. dollar fell by 35% tomorrow, what would that mean for the competitiveness of U.S. manufacturing? Would Airbus still be able to compete with Boeing? What about China’s low-frills EV sector with Tesla? Or Kubota with Deere? What do you think would happen to the demand for Miami Beach condos or brownstones in New York and Boston? The U.S. is still a manufacturing powerhouse and a country with desirable assets. If the U.S. could suddenly sell goods, services, and assets for 35% cheaper than our competitors, would that not drive up the demand for U.S. dollars and increase the dollar exchange rate? 

Fighting Inflation

One of our long-favored investing sectors is consumer staples. Why do we like consumer staples companies? Staples stocks tend to have durable competitive advantages, many in the form of brand value built up by decades of major advertising campaigns. Companies that produce food and household products are also less impacted by the business cycle than are auto firms, for example. Strong brand value, along with the non-discretionary nature of the goods, and their low wallet share, gives many consumer-staples firms pricing power. In an inflationary environment, when the cost of producing and transporting goods is rising, having the ability to pass those costs onto consumers without destroying either volume or market share is valuable.

Procter & Gamble is one of our long-held consumer staples stocks. P&G’s pricing power was on display in its latest quarterly results. For the third quarter, Procter & Gamble reported better-than-expected sales and profits. Both were helped by a 10% increase in prices. P&G also upgraded its outlook for 2023, forecasting fiscal 2023 organic sales growth of 6%, up from its previous projection of a 4% to 5% increase. 

Cash-Flow Machines

Procter & Gamble, as well as many of the consumer staples companies we own, generate significant amounts of free cash-flow. Free cash-flow is the cash left over after making capital investments to maintain and expand a business.

Companies that generate significant amounts of free cash-flow have the ability to pay healthy and increasing dividends, buy back shares, pay down debt, or make acquisitions.

Dividends are, of course, our favored use of a company’s free cash-flow. Dividends provide a degree of certainty in an uncertain market. Companies that pay reliable dividends provide cold, hard cash to shareholders regardless of the performance of the share price.

Dividend stocks also tend to hold up better in down markets than do non-dividend payers. For example, if a stock were yielding 4% today and the dividend was believed to be rock solid, there is a likely limit to how far investors would permit that stock to fall before buying it solely for the dividend yield.

Have a good month. As always, please call us at (800) 843-7273 if your financial situation has changed or if you have questions about your investment portfolio.

Warm regards,

Matthew A. Young
President and Chief Executive Officer

P.S. According to a recent WSJ article, apartments were the second-worst-performing real estate sector over the last year, falling 21%. Looking back at the red-hot real estate market in 2021, many investors believed that higher rents were baked into the cake for years to come. As such, a lot of money flowed into various residential REIT investments. Oftentimes when a sector has had a run-up, sentiment is positive, and the financial press is filled with headlines about the sector, it may be a warning flag to investors. Last year was a rough ride for residential REITs. The FTSE NAREIT Residential Property Index was down 31.3%. It’s prudent not to blindly lock onto the success of a stock or industry after it may have had a significant run-up.

P.P.S. Who knew? Apparently, award-winning musician Taylor Swift knows a thing or two about investment due diligence. According to The Telegraph, cryptocurrency trading platform FTX made a serious effort to secure Taylor’s endorsement. Among other questions, the singer asked, “Just tell me that these are not unregistered securities, right?” before she committed to anything.

As highlighted by The Telegraph,

Investing doesn’t need to be very complicated. A company makes products or provides services, charges money for it, and makes a profit. When it gets harder than that to understand, it is usually a swindle. Taylor Swift could see that and saved herself a lot of embarrassment by refusing to have anything to do with FTX. If a few more investment professionals could do that, the financial world would be a safer place.

P.P.P.S. A few helpful points of interest can be gleaned from a WSJ article titled “Why It’s Now Easier to Underestimate Your Expenses and Overspend.” “The power of compounding is a boon to investors, but not to shoppers. Money grows much faster than most people expect because interest is earned on interest,” said Michael Liersch, head of Wells Fargo & Co.’s advice and planning center. A similar concept applies to inflation: prices rise, and if inflation remains high, prices continue to grow on top of already-inflated prices, leaving people off guard. The article highlights how individuals may operate off an outdated budget, underestimate their future spending, and not factor in infrequent expenses. Individuals often ask me, “Matt, how much do I need to retire?” My response is, “How much do you spend in a year?” I stress the need to capture as many of your expenses as possible and review your annual expenses regularly. A trip to the nail salon or hair salon may not seem like a big deal, but they can add up, along with expenses like a housekeeper, new tires for the car, and certain major home repairs that occur every 10 years or so. You want to factor in frequent expenses like groceries and infrequent ones like the removal of tree branches from the front yard.

March 2023 Client Letter

My copy of Bogle on Mutual Funds by investment giant and founder of The Vanguard Group, John Bogle, sits on my desk as it always has during my 30 years in the investment management business. Bogle’s first chapter begins with our favorite investment strategy, compound interest. Clients know that the process of having money make money by way of reinvesting dividends and interest year after year is one way to achieve investment success.

Chapter 2 outlines another critical investment concept: risk. Bogle encourages readers to manage their investment affairs with prudence, intelligence, and discretion, and he advises them not to speculate. Further, he prompts readers to ask, “What risks are you prepared to take?”

Sitting next to my Bogle book is a copy of Benjamin Graham’s Intelligent Investor, which has been described as the best book on investing ever written. Graham, like Bogle, wastes no time on the subject of risk. The second sentence in the first chapter says, “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

Both Bogle and Graham were as concerned with not losing money as with making money. Both were also pretty good at arithmetic and understood that the greater the portfolio loss, the more challenging it is to make that money back.

The Arithmetic of Portfolio Losses

Understanding the arithmetic of portfolio losses is vital to crafting portfolios that may help you achieve long-term investment success. All investors should know that the market can go up and it can go down. What may not be appreciated by some is the sheer magnitude of gains needed to recover from a serious loss.

Small losses are easily recouped. For example, if your portfolio loses 1%, it only takes a 1.1% gain to get back to even. If your portfolio loses 5%, it takes about a 5.25% gain to get back to even. But what if you lose 15%? Does it only take 15% to get back to even?

Unfortunately, it does not. A 15% loss in one year requires a 17.6% gain to get back to even. Not unmanageable, but as the hole gets deeper the ladder needed to climb back out gets exponentially longer. For example, the additional gain needed to recover from a 15% loss is only 2.6% more than the loss (17.6% minus 15%); but when the loss is 40%, the additional gain required to get back to even is 26.7%. In the table below, I show the gain needed to recover from a loss in five-percentage-point increments.

The typical bear-market loss in the Dow or S&P 500 is around 35%. Investors who have decided on an all-stock portfolio should be willing to accept periodic losses of that magnitude. The gain needed to recover from a 35% loss is 54%.

What if you are an investor who favors NASDAQ stocks or the high-growth innovation stocks in an ETF like ARK Innovation (ARKK)? From a high in February of 2021 to a recent low in December, the ARK Innovation ETF fell just over 80%. Investors who bought at the all-time high will require a 400% gain to get back to even.

The ugly reality of the arithmetic of portfolio losses underscores why prudence is a vital component of portfolio management. Investors with a lower tolerance for risk, shorter time horizon, or those who require annual distributions from their portfolio are often better served with a portfolio that seeks to limit downside risk rather than one swinging for the fences.

This is especially true for retired investors taking income from their portfolios. A close cousin of the arithmetic of portfolio losses is sequence of returns risk. Sequence-of-returns risk is the risk of receiving lower or negative returns early in retirement when withdrawals are being made. Of course, you don’t have to be retired to face such risk. Any investor taking regular withdrawals from their portfolio should understand how the sequence of returns can impact portfolio longevity.

To illustrate, assume we have two investors, Jack and Jane. Feeling flush with their $1,000,000 portfolios, both decide to retire early, at age 62. (Evidently, neither investor is a client of Dick Young or Matthew Young!) Both invest their portfolios heavily in stocks. Therefore, we will assume their returns until age 96 average 7.3% per year with volatility that is commensurate with a stock-heavy portfolio.

Thus far Jack and Jane are in the same situation. They start with the same amount of money. They are investing for the same period of time and in the same type of portfolio with the same average annual return and volatility. The only difference we will make is to reverse the order of returns.

As you will recall from fourth-grade math, the commutative property says that the order of returns in a multiplication problem doesn’t matter. (Okay, I didn’t remember either, but it’s true nonetheless.) You can see in the table below by looking at the last row in the columns “Value Without Withdrawals” that the commutative property holds. Whew! At age 96, Jack and Jane both have almost $11 million despite Jane’s slow start. (As a side note, score one for compound interest. Turning $1 million to $11 million in retirement is impressive).

Now let’s assume that Jack and Jane must take income from their portfolio to help fund their early retirement. We will assume each takes $40,000 or 4% to start and they increase that draw by 2.5% per year to maintain purchasing power. The table below shows the annual income through time and their end-of-year portfolio value.

Look what happens to poor Jane. Even though Jane earns an average annual return of 7.3%, which is greater than the 4% initial withdrawal and 2.5% inflation adjustments, she still runs out of money at 79.

Jane’s withdrawals during negative return periods early in retirement permanently impair her portfolio. In stark contrast, lucky Jack’s portfolio is worth $6.5 million when he reached age 96.

Sequence-of-returns risk is a serious threat to retired investors and/or those taking portfolio distributions.

How to Reduce Sequence-of-Returns Risk

How can you reduce your sequence-of-returns risk? First, review your diversification. Spreading your assets across different sectors, industries, and especially asset classes can temper the large drawdowns that can lead to portfolio ruin when drawing income.

The most important component of your diversification should be a healthy bond allocation. If you are taking income, you have likely retired and no longer have the safety net of a regular paycheck to make up for big bear-markets. Notwithstanding last year, stocks and bonds don’t often move in lockstep. The chart below shows the performance of intermediate-term government bonds in down years for the S&P 500. Since 1950, on 14 of the 16 occasions when stocks were down, intermediate-term Treasuries were up. The dampened volatility of a balanced portfolio that includes stocks and bonds can help reduce sequence-of-returns risk.

Secondly, be sure you take a reasonable amount of income from your portfolio. What’s reasonable? It will vary based on your age and individual circumstances; but for investors starting retirement at 65, our general guidance is to stay at or below 4% and ideally shoot for something closer to 3.5%.

Finally, while nobody hopes for this outcome, if you do find yourself experiencing a big down-year in your portfolio and you have the ability to reduce your income for a year or two, do it. Giving your portfolio some time to recover can make a meaningful difference in mitigating sequence-of-returns risk.

Is Your Bond Allocation Where It Should Be?

Ensuring your bond portfolio is up to par has been challenging over the last 10 to 15 years. The Fed’s misguided policy of holding interest rates at zero and pushing longer-term bond yields lower via quantitative easing for much of this period has meant slim pickings for interest income. Today, the calculus is much more appealing.

Two years ago, short-term T-bill yields were close to zero, two-year Treasury notes paid a scant 0.20%, and if you were looking for something in the intermediate-term space like a five-year maturity, you had to settle for less than 1%. Today, even after the flight to safety bid in Treasuries from the Silicon Valley Bank failure, six-month Treasuries pay nearly 5%. Two-year Treasury notes pay you about 4.2%, and five-year notes offer a yield of 3.75%.

The power of compounding works better when there is something to compound. By example, at a 0.20% yield, it would take about 350 years to double your money. At today’s two-year Treasury note yield of 4.2%, it would take 17 years to double your money.

Implications of the Silicon Valley Bank Failure

The failure of Silicon Valley Bank (SVB) and Signature Bank has the potential to act as a catalyst for a meaningful change in the trajectory of the economy. Up to this point, the economy had responded relatively well to the Fed’s interest-rate hikes. We have seen a slowdown in the interest-sensitive sectors of the economy; but employment remains strong, and the consumer is in good shape. Core inflation, which smooths out the volatility in headline inflation, is also still running hot, which may be a sign growth is still strong. Core inflation has increased by 5.5% over the last year, with the six-month annualized rate not much better at a still elevated 5.1%. Before the SVB failure, some economists believed the Fed would need to increase rates to 6% from 4.75% today to bring inflation back down to target. We haven’t heard much about 6% Fed funds since SVB collapsed.

Its collapse not only caused a run on uninsured deposits, which is the immediate problem; but if the situation isn’t resolved quickly, we may be looking at a step-change in the availability of credit. Regulators and bank executives are likely to pursue more liquidity, more capital, and lower risk. All tend to translate into tighter credit conditions, which hampers economic growth.

It is, of course, too early to draw definitive conclusions on the economic impact of the liquidity crunch in the banking system, but its potential to be meaningful should not be discounted. While we didn’t forecast that a series of poor decisions at a modest-sized bank would catalyze a liquidity crunch in the banking system, we have been scaling back risk. As the business and credit cycles have evolved, we have ramped up most of our clients’ full-faith-and-credit-pledge Treasury holdings to 30% or more of their fixed-income holdings. We also exited bond positions rated below investment-grade in the first half of 2022. On the equities side of portfolios, we continue to hold much higher percentages of defensive shares than are represented in the broader stock-market indices.

Have a good month. As always, please call us at (800) 843-7273 if your financial situation has changed or if you have questions about your investment portfolio.

Warm regards,

Matthew A. Young
President and Chief Executive Officer

P.S. With control of Congress now split, fights over raising the debt limit will likely end up back in the headlines. If the debt limit isn’t raised, could the U.S. default on its debt? A recent op-ed in the WSJ makes clear that a U.S. default on debt would be unconstitutional:

Section 4 of the 14th Amendment is unequivocal on that point: “The validity of the public debt of the United States, authorized by law,… shall not be questioned.” This provision was adopted to ensure that the federal debts incurred to fight the Civil War couldn’t be dishonored by a Congress that included members from the former Confederate states.

The Public Debt Clause isn’t limited to Civil War debts. As the Supreme Court held in Perry v. U.S. (1935), it covers all sovereign federal debt, past, present and future. The case resulted from Congress’s decision during the Great Depression to begin paying federal bonds in currency, including those that promised payment in gold. Bondholders brought an action in the Court of Claims demanding payment in currency equal to the current gold value of the notes. The justices concluded that Congress had violated the Public Debt Clause and that its reference to “the validity of the public debt” was broad enough that it “embraces whatever concerns the integrity of the public obligations.”

That means the federal government can’t legally default. The Constitution commands that creditors be paid. If they aren’t, they can sue for relief, and the government will lose and pay up.

P.P.S. With the real estate sector slowing in recent quarters and mortgage rates more than doubling from a year ago, some are concerned about a housing market collapse. According to CNN Business, at the national level, demand for homes still outnumbers supply. “In the decade between 2012 and 2022, 15.6 million households were formed. During the same time period, 13.3 million housing units were started, and 11.9 million were completed. This includes 9.03 million single-family homes and 4.2 million multi-family homes. Of those, only 8.5 million single-family homes and 3.4 million multi-family homes are completed.”

P.P.P.S. If you have a decent amount of money stashed in a basic savings account at a major bank, there is a good chance you’re earning next to nothing on those deposits. Yes, the Fed has been steadily raising interest rates for about a year, but this has not yet translated into higher rates in bank savings accounts. According to the St. Louis Fed, savings account rates average a measly 0.35%. Fortunately, Fidelity is paying you much more in your money market account. The current rate on the Fidelity Treasury Money Market is 4.2%.

P.P.P.P.S. We recently updated both Part 2A and Part 2B of our Form ADV as part of our annual filing with the SEC. This document provides information about the qualifications and business practices of Richard C. Young & Co., Ltd. If you would like a free copy of the updated document, please contact us at (401) 849-2137 or email cstack@younginvestments.com. Since the document was last updated in March 2022 there have been no material changes.

February 2023 Client Letter

One of the more endearing characteristics of a stock, in our view, is its belonging to a company with a history of raising its dividend. That’s because if you own the stock, consistent dividend increases raise the yield on your original cost basis. Patient investors realize that a modest yield today can grow significantly in the future.

Throughout the year, your monthly brokerage statement shows the dividends paid into your account. When viewed individually, these payments may not appear as large numbers. But when aggregated for an entire year, you may be pleased with the final figure.

We target companies with track records of making annual dividend increases. Typically, these increases are in the single-digit percentage range. But as time passes, these annual increases have a big impact on the future dividends you receive.

By example, take a hypothetical portfolio with $1 million invested in dividend payers. Assume a starting yield of 3% and annual dividend growth of 6%. After 20 years, that initial $30,000 in dividend income will have increased to $96,214. In two decades, the dividend yield on the original cost basis climbs to 9.6%.

After 25 years of dividend increases? The original $1 million will generate $128,756 in annual income or a yield of nearly 13%, which doesn’t include the additional dividend income that would be generated by reinvesting dividends. That’s the magic of compound interest. Or, as Ben Franklin said, “Money makes money. And the money that makes money makes more money.”

Our Retirement Compounders® (RCs) equity program targets consistent dividend payers. The longer the record of regular dividend payments, the better. Companies that have paid consistent dividends through numerous economic expansions and contractions are often quality businesses.

In the RCs, we favor firms with consistent records of paying regular dividends, but we also like firms that have consistently increased annual dividends. A growing stream of dividend income may be able to solve problems for investors.

Dividend growth can help offset the impact of inflation on the purchasing power of your retirement portfolio. Companies that pay meaningful dividends and raise those dividends over time also provide a more meaningful foundation for long-term capital appreciation.

Non-dividend payers can be subject to the whims of temperamental investors. Consider a stock that pays no dividend and has risen in price because investors believe the firm’s prospects have improved. DocuSign is a recent example with which many of you are likely familiar.

DocuSign is the leader in e-signature technology. During COVID, many investors discovered the ease of doing business with DocuSign. Prior to COVID, DocuSign shares were performing well as e-signature adoption was increasing and awareness proliferating. Post COVID, the shares went bananas, to use a technical term. In February of 2020, DocuSign shares were trading around $86. At $86 per share, DocuSign was trading for roughly 16X sales. Sales for the prior 12 months were approximately $1 billion. Once COVID hit, sales took off, and so did the share price. The stock went from $86 in February of 2020 to a high of $310 in the summer of 2021. By September of 2021, sales had doubled, and the price investors were paying for each dollar of sales had also doubled. Investors were apparently anticipating even faster growth than the firm experienced when the conditions for e-signature couldn’t have been better.

Today, DocuSign does annual sales of about $2.5 billion, a significant growth from the early 2020 levels, but investors’ opinions of DocuSign’s future prospects have dimmed. DocuSign shares now fetch $59 per share, which equates to about 4.9X sales. Investors who bought shares at the all-time high are nursing an 80% loss despite a solid performance from the underlying business.

Compare DocuSign to a hypothetical dividend-payer. I’ll keep the arithmetic simple for illustrative purposes. Assume a starting share price of $100, an annual dividend of $3, and a dividend growth rate of 7.2%. At 7.2% growth, the dividend will double in 10 years. To maintain a 3% yield in 10 years, the share price would also have to double. A cold hard stream of cash you can deposit in the bank provides a more meaningful foundation for capital appreciation than an increase in sales, which is a more abstract concept to shareholders.

What other problems can dividend stocks help investors solve? Bear markets aren’t fun for anybody. This is especially true for those in or nearing retirement. Retired investors may rely on their portfolio for income, and those nearing retirement simply don’t have as much time to make back any losses. While not a cure-all, stocks with a consistent record of paying and increasing dividends tend to fall less in bear markets than do non-dividend-payers. Why? Not only are companies that consistently pay and increase their dividends most often more stable and cash-generating; but when prices fall, a reliable dividend can provide a floor under the price as yields rise. Dividend consistency is comforting during periods of market volatility like we have today. The current bout of volatility has been wicked for non-dividend-payers and high-growth/technology companies. You may recall from previous letters that technology shares have come to dominate the S&P 500. Apple, Amazon, Google, Facebook, Microsoft, Nvidia, and Tesla are among the largest stocks in the index.

The table below lists the worst-performing large-cap high-growth/technology companies in the S&P 500 last year.

Select High-Growth/Technology Stock Performance 2022

Worst seven performing stocks in 2022 included in the S&P 500 Growth, S&P 500 Communications Services, or S&P 500 Information Technology indices that had a market capitalization of $100 billion or more on December 31, 2021.

If you broaden the list to include growth stocks in the Russell 1000 Index (1,000 largest companies), the losses are even more pronounced. The list below shows how much each company is down from its high price over the prior three years.

Biggest losses from 3-year high in Russell 1,000 Growth

How did dividend-paying companies perform during last year’s bear market? The average dividend-paying stock in the S&P 500 was down 5.8% compared to a 23.6% loss for the average non-dividend-payer.

Dividend stocks may not perform as well in all bear markets as they did in the 2022 bear market, but we continue to like the risk-adjusted prospects for dividend strategies. Below I’ve profiled some of our more favored dividend-payers today.

General Dynamics

General Dynamics is a global aerospace and defense company that specializes in high-end design, engineering, and manufacturing of products and services in business aviation, ship construction and repair, land combat vehicles, weapons systems, and munitions. General Dynamics has increased its dividend for 30 consecutive years. Over the last five years, the dividend has compounded at a rate of 8.45%. We anticipate a similar rate of growth in the future. Today the shares offer a yield of 2.2%.

T. Rowe Price

T. Rowe Price Group is a financial services holding company that provides global investment management services through its subsidiaries to investors worldwide. The company provides an array of U.S. mutual funds, sub-advised funds, separately managed accounts, collective investment trusts, and other T. Rowe Price products to its customers. T. Rowe Price has increased its dividend every year for 35 years. T. Rowe Price shares yield 4.15% today. Barring a major market melt-down over the coming years, we estimate mid-to-high single-digit dividend growth.

Air Products

Air Products (APD) is in the industrial gases business. APD produces and distributes atmospheric, process, and specialty gases worldwide. Air Products generates more than 60% of its revenue outside of the U.S. APD has increased its dividend for 40 consecutive years. Over the last three years, the dividend has risen at an almost 12% compounded annual rate. The shares offer a respectable yield of 2.2% today.

Chevron

Chevron is one of the world’s largest integrated energy companies and the only energy company left in the Dow Jones Industrial Average. Chevron finds, develops, refines, and markets oil and natural gas. Chevron has raised its dividend every year for over three decades.

Medtronic

Medtronic is a leading manufacturer of medical devices. Medtronic’s medical device products treat a range of diseases and disorders. The company divides its business into cardiovascular products, medical surgical products, neuroscience, and diabetes. Medtronic has increased its dividend for 13 consecutive years, with dividend growth averaging about 8% over the last five-, three-, and one-year periods. After struggling in 2022, Medtronic shares offer a yield of 3.3% today.

Fed Watch

Over the last year, many investors have been focused on the Fed’s fight against inflation. The Fed has gone on one of the most aggressive rate-hiking cycles in history. It may be hard to believe, but the first interest rate increase of this hiking cycle was only 10 months ago. At its most recent meeting, the Fed pushed its policy rate up to 4.50%–4.75%—the highest level in 15 years. And with the Fed signaling another one-to-two-quarter-point hikes early this year, we may soon see Treasury bills and short-term notes with yields exceeding 5%.

The Fed’s aggressive rate-hiking campaign is a welcomed development in our view. Fifteen years of near-zero-percent interest rates placed a costly burden on savers and retired investors. Stock and bond prices have started to adjust to today’s interest rate realities, but hope springs eternal. There are still many investors banking on the idea that the Fed will do another about-face and cut interest rates later this year. 

These investors should be careful of what they wish for, as rate cuts may come with an economic and corporate earnings recession. We would much prefer to see the Fed hold the line on rates and see the economy avoid recession, but we don’t craft portfolios based on one possible outcome. We craft portfolios with a range of possible outcomes in mind, both positive and negative. 

A 4% Yield on Your Fidelity Money Market

Despite the adjustment lower in stock and bond prices due to the end of the free money era, there are major benefits to higher interest rates. Take your Fidelity Money Market fund by example. After offering investors close to no yield for the better part of 15 years, your Fidelity Money Market now pays close to 4%. Another one or two hikes could push rates above 4.5%. At a 4.5% yield, you would double your money every 16 years. At a 0.25% yield, it would take 288 years to double your money. Money market yields are also much more attractive than the yields offered by many banks today. According to Bankrate.com, the national average three-month certificate of deposit (CD) rate is only 1.38%. These rates will likely converge over the longer run, but if you are currently sitting on a pile of cash in a bank account, you might consider a higher-yielding alternative.

In addition to the higher yield on money market funds, Treasury and corporate yields are also at attractive levels. Short-term Treasuries offer yields in the 4–4.5% range, and short-to-intermediate-term corporate bonds offer yields of 4%–5% depending on maturity and rating. 

Have a good month. As always, please call us at (800) 843-7273 if your financial situation has changed or if you have questions about your investment portfolio. 

Warm regards, 

Matthew A. Young
President and Chief Executive Officer 

P.S. For most portfolios, we favor individual securities over open-end mutual funds. The problems with open-end mutual funds are varied. One big drawback with mutual funds is taxes. With the major stock and bond indices both down double digits in 2022, one would think capital gains taxes wouldn’t be a worry. Unfortunately, for many open-end mutual fund investors, a down market can still mean taxable capital gains distributions. Take the Vanguard Wellesley Income fund as an example. Wellesley was down 9% last year, but the fund still made a significant capital gains distribution equal to about 4.5% of the fund’s net asset value. The problem isn’t unique to Vanguard Wellesley. The problem is with open-end mutual funds. In down markets, more shareholders than usual tend to sell their mutual funds. As investors cash in their holdings, portfolio managers have to raise cash to meet the redemptions by selling securities. Significant redemptions can force a fund manager to sell positions held at substantial gains. Patient shareholders who stayed the course during the market turbulence end up footing the bill for the impatient investors who bailed out. When you own individual securities, the capital gains are realized only when you place trades. Therefore, your patience may be rewarded instead of punished.

P.P.S. In light of roaring inflation, the slight drop in the price of gold in 2022 came as a surprise to some. If gold is an inflation hedge, why was it down 0.5%, with inflation soaring to 6.5% in 2022? Gold is an inflation hedge, but it is a long-term hedge. Over the shorter run, the strength of the dollar and interest rates play an important role in the performance of gold. While inflation was up big last year, interest rates soared, and so did the dollar. Since early November, when longer-term interest rates and the dollar topped out, gold prices have rallied 18%. Gold is also likely benefiting from central bank purchases. Central banks bought more gold last year than they have in over five decades. Regardless of gold’s short-term price action, we continue to buy gold and view it as an important component of a well-diversified portfolio. 

P.P.P.S. At Richard C. Young & Co., Ltd., we seek to avoid the speculative elements in the market by pursuing a balanced approach. A mix of bonds, dividend-paying stocks, and precious metals has most often helped limit risk in our clients’ portfolios while delivering an acceptable return. A well-diversified balanced portfolio will probably never earn the highest return in any single year, but it is also unlikely to deliver the worst return. 

P.P.P.P.S. Consumer-staples stocks have long been one of our favored sectors. Why? For starters, the dampened cyclicality of the sector provides a greater degree of confidence in the long-term prospects of firms in the space. Many companies in the staples sector are durable businesses with long operating histories and formidable brand portfolios. What startup will outspend P&G to gain market share in diapers or detergent? Or, when was the last time you saw a new candy bar not created by one of the big incumbents gain a foothold on store shelves? The barriers to entry in the branded consumer goods industry are significant. 

P.P.P.P.P.S. In 2022, many were concerned that oil producers would not be able to respond to the significant increase in oil prices due to concerns over a lack of permitting. But, according to the Financial Times, America’s largest oilfield, the Permian Basin, has seen crude production soar to a record high:

At 5.6mn barrels a day, the field now accounts for almost half of all the oil produced in the US, pumping more than many OPEC countries. The state of New Mexico’s crude production last year eclipsed output from the entire country of Mexico. … Oil and gas producers deployed 350 drilling rigs in the region last week, up by about a fifth from the same time last year, according to data collected by Baker Hughes. Other jobs have followed, from truck drivers and mechanics to hotel cleaners and construction workers.

November 2022 Client Letter

A year ago, when cryptocurrencies were trading at their all-time highs, I was interviewed by CNBC. According to CNBC, financial advisors like me were divided on whether it was too soon or too risky to put clients’ money into cryptos. The article looked to establish whether to invest or not.

I explained to the interviewer that I had struggled to develop an investment thesis to justify any meaningful purchase of cryptos other than speculation. The commonly cited benefits of cryptos include an alternate form of money, a store of value, a hedge against inflation, and benefiting from a limited supply.

I take issue with all these points. I view money as something that is stable. To my mind, cryptos fail in the stability category. One hundred dollars worth of crypto today might be worth a whole lot less in the future. Perhaps a few cryptos will someday be viewed as stores of value, but that time is not here. Gold has been around for a millennium and is probably the better asset if stored value is the goal. Where is the proof that cryptocurrencies can keep pace with inflation? I view stocks as the better inflation hedge. And limited supply? Not quite. There are thousands of cryptocurrencies. Anyone can create a virtual currency and market it to investors. As I noted to CNBC, “Regulation is not yet here with these cryptos.”

When it comes to allocating your hard-earned savings, Richard C. Young & Co., Ltd believes an emphasis on investment versus speculation puts the odds of future success in your favor.

We have felt this way for decades and have developed much of our investment philosophy based on the work of the father of value investing, Ben Graham, and that of Vanguard founder Jack Bogle. In his book, Bogle On Mutual Funds, Bogle wrote about the risks of investing:

Manage your affairs with prudence, intelligence, and discretion. Do not speculate. Consider probable income as well as probable safety of capital. Recognize that there is no avoiding risk of one kind or another. For instance, holding cash—or hiding it in the proverbial mattress—at best assures no earnings on your capital and, at worst exposes it to erosion by inflation. So the question is: What kinds of risks are you prepared to take?

I can’t speak for all my clients, but I gather many of you, like Bogle suggests, treat income, safety of capital, and protection against inflation as investment priorities. 

Stocks can be an attractive asset for generating income and protecting against long-run inflation risk, but many stocks may not be appropriate to meet these goals. High growth or aggressive growth strategies tend to favor shares that pay low or no dividends. And some firms that operate in these high-growth areas are more susceptible to deflationary forces within their industries.

Investing in dividend-paying stocks is how one generates income from an equities portfolio. Dividend stocks also tend to hold up better than high-growth (valued highly) and non-dividend-paying stocks in an inflationary environment that leads to higher interest rates.

Lawrence Strauss recently highlighted some of the benefits of investing in dividend payers in the current environment. He wrote in Barron’s:

Dividend stocks have been relative winners in this year’s market selloff. Dividend-paying shares in the S&P 500 Index are down 11%, including dividend income, compared with declines of 19% in the S&P 500 and 23% for non-dividend stocks. Bonds aren’t doing much better. The Bloomberg U.S. Aggregate Bond Index is off 16%, its worst performance on record going back to 1988.

Dividend stocks’ relative strength reflects a few factors. Payouts cushion against sliding share prices. And the dividend payers congregate in value sectors, such as financials, energy, and utilities, which have outpaced growth sectors, such as tech, where dividends aren’t as generous or widespread.

At Richard C. Young & Co., Ltd, we craft stock portfolios for clients that are invested exclusively in dividend payers. We favor higher yields, as most would, but yield is not our only criterion, and it is not the most important variable. In fact, investing only in the highest-yielding stocks can lead to inferior results. Ultra-high yields are often a signal from the market that a firm’s dividend is at risk.

In addition to yield, we evaluate firms’ dividend consistency, records of making regular annual dividend increases, prospects for future dividend growth, and dividend safety. Not every stock we purchase is strong in every category. Some firms pay high yields but have low dividend growth prospects, while others have strong dividend growth prospects but low yields. Then there are some firms that have moderate yields and moderate growth prospects but multi-decade records of paying and increasing dividends.

Blue Chip Dividend Stocks

This latter group tends to be more blue-chip in nature. Examples of some of the firms I would put in this category include Air Products & Chemicals, Procter & Gamble, and Johnson & Johnson.

Air Products and Chemicals

Air Products and Chemicals, Inc. (APD) produces industrial atmospheric and specialty gases and performance materials and equipment. The company’s products include oxygen, nitrogen, argon, helium, polyurethane, epoxy curatives, and resins. APD’s products are used in the beverage, health, and semiconductor fields. Selling industrial gas is an attractive business. There is nothing proprietary about the gases and chemicals Air Products sells, but they are essential inputs of the manufacturing processes of many firms. For many customers, industrial gases are also a low-cost input, which makes buyers less interested in price shopping and more interested in the reliability of supply. Air Products has paid a dividend every year since 1954, and it has increased the dividend for the last 40 consecutive years. Its shares yield 2.2% today. Twenty years ago, the shares also offered a yield of about 2.2%. Since then, the dividend has compounded at 10.8%. Not surprisingly, if you add the starting yield of 2.2% to the 10.8% dividend growth rate, you get a figure of 13%, which almost exactly matches the two-decade total return of 13.1% in the stock.

Procter & Gamble

Procter & Gamble produces products that are a part of most consumers’ everyday lives. Crest toothpaste, Tide detergent, Pampers diapers, Gilette razors, and Bounty paper towels are just a few of the firm’s 60+ brands. P&G also has one of the most impressive dividend records of any stock. P&G has paid a dividend every year since 1891, and it boasts a 69-year record of making annual dividend increases. P&G shares yield 2.6% today.

Johnson & Johnson

Johnson & Johnson is a diversified healthcare firm. The company has large businesses in pharmaceuticals, medical devices, and consumer health products. The healthcare industry benefits from favorable demographics (an aging population), strong pricing power, and recession resistance. JNJ’s diversified business mix and the recession-resistant nature of healthcare have made it one of the more stable and reliable blue-chips an investor can purchase. JNJ is the least volatile stock in the S&P 500 (as measured by monthly 10-year standard deviation). It also has one of the highest financial strength ratings among companies in America. JNJ is one of only two companies that are still rated AAA by S&P. In the early 1980s, there were 60. JNJ has paid a dividend every year since 1944 and has raised the dividend for the last 58 consecutive years. The shares yield 2.6% today.

Dividend Increasers

Some of the firms we own that have strong prior and prospective dividend growth are Home Depot and Texas Instruments.

Home Depot

Home Depot is the world’s largest home improvement retailer. Home Depot’s scale gives it negotiating power with suppliers and a logistical advantage when delivering to its pro businesses. Home improvement retail has also been relatively insulated from e-commerce competitors. Over the last decade, Home Depot’s dividend growth has averaged 20%. Over the next couple of years, with headwinds expected for the housing and remodeling markets, we expect dividend growth will average 8–10%—still an impressive growth rate for one of America’s largest retailers. 

Texas Instruments

Texas Instruments is a leader in analog chips, which convert real-world signals into digital signals. The analog chips business has attractive economics. Like the industrial gases sold by Air Products, analog chips are a lower-cost input. Unlike industrial gases, which are commodities, analog chip designs often have proprietary designs, and customers build those specially designed chips into the products they are making. The hassle of changing analog chip makers to save a couple of bucks isn’t worth it for most firms. This allows Texas Instruments to earn high returns on the money it invests in its business. Texas Instrument’s five-year average return on capital ranks among the best in the S&P 500. High and reliable returns on capital have allowed TXN to increase its dividend at a 22% annual rate over the last decade and a 17% annual rate over the last five years. Today, the shares yield 2.8%.

High Dividend Yield Stocks

Some of the high-yielding stocks that we own in common stock portfolios include Verizon, Avista, and Kinder Morgan.

Verizon

Verizon is about as boring a business as one can invest in. The industry is mature, growth prospects are modest, and international expansion is unlikely. That doesn’t make Verizon a bad investment. Verizon generates loads of cash flow that it returns to shareholders in the form of dividends. The dividend yield on the shares is an impressive 6.8%. The dividend doesn’t increase much every year, but it should keep pace with inflation over time. What is there to hate about a 6.8% yield and 2–3% dividend growth in a known commodity like Verizon?

Avista

Avista is a regulated utility in the Pacific Northwest involved in the production, distribution, and transmission of electricity and natural gas. Avista has operations in Washington, Oregon, Idaho, and Alaska. The company has over 400,000 electricity customers and almost 370,000 natural gas customers. Almost 50% of Avista’s electricity generation comes from hydroelectric power, with 60% of the firm’s total electricity production coming from renewable sources. Avista shares yield 4.6% today, and the company has increased its dividend every year for the last 20 consecutive years.

Kinder Morgan

Kinder Morgan is one of the largest energy infrastructure companies in North America. Kinder Morgan owns an interest in or operates 83,000 miles of pipelines, 141 storage terminals, and 700 billion cubic feet of natural gas storage. Oil and gas pipelines and storage facilities are some of the most attractive energy stocks to own for dividend investors. Most energy firms are capital intensive, and the same is true of pipelines and terminals, but unlike oil and gas producers, which must reinvest most of their profits back into the business to maintain their asset bases, pipeline firms have low ongoing capital maintenance requirements. Once the large initial cash outlays are made to lay pipe or build a terminal, most of the cash flows those assets generate can be paid out to shareholders in the form of dividends. Kinder Morgan shares yield 5.95%. Over the last five years, Kinder Morgan’s dividend has compounded at an annual rate of 17%.

Investing is a Process

At the bottom of our letterhead is our tagline, which reads, “diversification and patience built on a foundation of value and compound interest.” The “patience” part of this phrase equates to time. Time can be an overlooked ally of successful investors. It’s difficult to outsmart the markets, especially during shorter periods. The markets can go up when there are bad headlines and go down when there are good headlines. Kneejerk reactions and selling during these periods can lead investors to outfox themselves and then miss out on potential gains or realize unneeded losses.

The WSJ recently profiled various Americans who are planning their retirements, noting the difficulties they have faced this year.

The WSJ article mentions that “Susan Hodges, 66, and her wife decided to pull all their money out of the markets in May. ’We can only take so much anxiety,’ she said.”

There are all sorts of things wrong with Susan Hodges’s situation. Why on earth would Hodges and her wife pull all their money out of the markets? Few professionals would recommend such a strategy. You do not want to be in a position where volatility makes you so uncomfortable that you get out. Perhaps she is not receiving thoughtful investment counsel on how to craft a portfolio calibrated to match her ability and willingness to take risks. I tell clients all the time that it’s fairly easy to stay the course when you have J&J, P&G, Visa, and U.S. Treasuries on the books. Hodges and her wife may also have been drawing too much from their portfolio annually, which can really accelerate declines in value during years like 2022. Once again, she was maybe not getting good advice on annual withdrawal amounts, tracking or adjusting annual expenses, life expectancy, etc.

The article notes that Hodges now has 10% of her portfolio in the stock market, but it doesn’t say when she got back in. It is entirely possible she lost money with the 10% she reentered with. She is not giving time a chance to do the heavy lifting. Stocks are cyclical, and they can be volatile in the short run, but the historical record (1927–2001) shows that over periods of 15 years or more, investors have never experienced a negative return.

Stocks Have Entered the Best Year of the Election Cycle

This year, Election Day arrived in the midst of global economic and geopolitical uncertainty, including a war over the horizon, inflation, rising interest rates, and the tail end of economy-shattering pandemic lockdown measures. The results of the election were mixed, with the GOP taking control of the House of Representatives and the Democrats holding the Senate. As we wrote to you in September, such a divided government has traditionally coincided with stronger stock markets.

But it isn’t just who controls the branches of government that correlates with positive investment outcomes, it’s also the timing of the election cycle. According to a study by US Bank, after every midterm election since 1939, America has seen its stock market rise in value. That’s an impressive 83-year record. The phenomenon is called the “midterm effect,” and it is heavily studied because of its persistence in delivering above-average returns. It hasn’t seemed to matter which party won or which was in power. The study also found that since 1962, the S&P 500 has returned an average of 15% in the first six months following the midterm elections. Average returns in the first six months of years without midterm elections have only been 4%.

In 2018, a second study by researchers from Australia and the United States found that “US equity premiums over the last 145 years average 15.41% annualized in months following midterm elections, yet only 2.98% in other months. The 12.43% annualized premium difference is both statistically and economically significant.” Their research suggests the midterm effect is considered a major public announcement, and may therefore have an effect on markets similar to that of other public announcements such as payroll numbers, GDP, and industrial production.

A third study of the midterm effect published by researchers from New Zealand’s University of Canterbury suggests the effect of the midterm elections on stock prices is so strong it “tops any effect associated with the election of a president and indeed any other calendar- and politically-related pattern.” The study also suggests that the benefits of the midterm effect are shared across industries. After studying 49 industry portfolios, the researchers found “higher excess returns around midterm elections for most industry portfolios.”

The exact cause of the midterm effect is still uncertain, but there’s no debate about its existence.

Have a good month. As always, please call us at (800) 843-7273 if your financial situation has changed or if you have questions about your investment portfolio.

Warm regards,

Matthew A. Young
President and Chief Executive Officer

P.S. Details of the collapse of cryptocurrency exchange FTX are still unfolding, but early reports suggest at least $1 billion in client funds may have disappeared. Former Treasury Secretary Larry Summers said FTX’s collapse is similar to other major bankruptcies in recent decades.

“A lot of people have compared this to Lehman. I would compare it to Enron,” Summers told Bloomberg’s Wall Street Week. Summers described some aspects of FTX’s downfall that reminded him of Enron: “The smartest guys in the room. Not just financial error but, certainly from the reports, whiffs of fraud. Stadium namings very early in a company’s history. Vast explosion of wealth that nobody quite understands where it comes from.”

P.P.S. Investors can benefit from some early takeaways from FTX’s demise. For starters, those depositing their assets into FTX were doing so in a firm that was not a brokerage firm or bank registered and regulated in America. Accordingly, these investors forfeited protections that could have reduced financial loss, including regulatory oversight, and federal insurance through the Securities Investor Protection Corporation or FDIC deposit insurance. Additionally, because FTX was not an American regulated financial firm or publicly traded company, it was not required to publish financial documents investors typically use to evaluate a business and conduct due diligence. As noted earlier in this letter, you want to manage your financial affairs with prudence, intelligence, and discretion. If Jack Bogle were alive today, I’m quite sure he would have thought FTX did not pass the smell test.

P.P.P.S. Consumer staples shares have long been one of our favored groups. Why? For starters, the dampened cyclicality of the sector provides a greater degree of confidence in the long-term prospects of firms in the space. Many companies in the staples sector are durable businesses with long operating histories and formidable brand portfolios. Consumer staples stocks, and reliable dividend payers in general, rarely receive media hype compared to the newest technology firms in the NASDAQ; but when you are in the business of long-term compounding, boring, routine, and dull stocks are desirable.

P.P.P.P.S. In the fourth annual CNBC FA 100 ranking (2022), Richard C. Young & Co., Ltd. was again recognized as an advisory firm that helps clients successfully navigate their financial lives.

* Rankings published by magazines, and others, generally base their selections exclusively on information prepared and/or submitted by the recognized advisor. Rankings are generally limited to participating advisors and should not be construed as a current or past endorsement of Richard C. Young & Co., Ltd. CNBC is a trademark of CNBC LLC. All rights reserved.

October 2022 Client Letter

By year-end 1993, I had about 18 months experience in the investment industry. During that short period, I had it relatively easy. The U.S. economy was enjoying its 33rd straight month of economic expansion, interest rates were still on the low side, and inflation was tame. As we rolled into 1994, it appeared we could have another year of market stability.

The Fed had held interest rates at around 3% for the previous 18 months. Interest rate hikes had not been a consideration for markets. As we know from this year, things can go a lot better when concerns about Fed hikes are not on the table.

But the ugliness began on February 4th when the Fed decided to raise rates by 0.25 percentage points. This was the first of many unexpected rate increases. And what initially looked to be a promising year resulted in the worst bond market in history. As the Fed raised rates, the bond market wreaked havoc on financial companies, hedge funds, and bond mutual funds.

Fortunately for our clients, we were invested in high-quality bonds with intermediate maturities. No junk, no leverage, no complicated derivatives. So, while our clients saw a decline in the value of their holdings, they could take relative comfort in their portfolio of safe-haven U.S. Treasury securities. Interest payments would be uninterrupted, and the principal would be paid back at maturity.

Bonds Play Role in Portfolios   

This year has also been an ugly one for bondholders. Some investors are now questioning if bonds should still play a role in their portfolios. The Bloomberg U.S. Aggregate Bond Index (the Dow or S&P 500 of the bond market) is down over 16% YTD. That’s still better than the 20% YTD drop in the S&P 500 and the 30% loss in the tech-heavy NASDAQ; but it’s disappointing nonetheless.

Notwithstanding 1994 and 2022, we continue to believe that bonds belong in a well-diversified portfolio. In our view, this year’s poor performance is likely an aberration caused by global central banks holding interest rates at zero or less for more than a decade, which drove yields across a wide spectrum of bonds to historic lows. When the starting yield on a bond is at ultra-low levels, less interest income is available to buffer price declines when interest rates increase.

Historically, it is rare for bonds to decline in a calendar year. According to Morningstar, since 1926, bonds have had only 15 annual declines, and the magnitude of those declines averages a scant 2.4%. Stocks have experienced 26 annual declines over the same time, with an average loss that exceeds 13%.

In terms of portfolio construction, it’s also important to remember that bonds tend to counterbalance stocks. The chart below is probably familiar to many long-time readers of this letter. It shows the return of intermediate-term government bonds during down-years for the S&P 500. The time period is 1950–2021. If 2022 ended today, it would be only the second time in the last 72 years that both bonds and stocks lost value in the same year. The historical odds would change from a 93% likelihood of government bonds rising in down stock-market years to 88%. Those odds still look favorable in our book.

Bonds Less Risky Than Stocks

Bond returns tend to be less volatile than stock returns because stocks and bonds are different animals. Bonds are like loans. Bondholders receive mandatory periodic interest payments in exchange for lending money. The amount loaned is the amount that must be paid back at maturity, and the interest rate is set at the time of issuance. In other words, absent a default, you know what your bond will be worth at maturity and how much you will be paid to hold it until maturity. That reduces risk. Contrast that with stocks where dividend payments are optional, there is no maturity, and the future value of a company depends on the earnings profile of that business and how other investors appraise that business at some future date. Lots of unknown variables must be assessed.

Bondholders are also senior in the capital structure to stockholders. What does that mean? If a company goes bankrupt, bondholders are repaid before stockholders. Stockholders typically lose everything when a company goes bankrupt, but bondholders usually get something back. It might be as little as 10% or as much as 70%; but, most often, it’s something.

Holding Bonds to Maturity

Keep this in mind: Although the unrealized losses on some of your bonds may rival the unrealized losses on some of your stocks, there is greater certainty about what you’ll earn on a bond that is down. Let’s look at a hypothetical example: An investor purchases a five-year government bond for $1,000 when interest rates are 2%. One year later, when interest rates increase by 3%, the price of that bond will be about $892.

Okay, so the bond is down in price. But unless somebody is forcing our investor to sell, the loss is temporary. Bonds mature at face value, or $1,000 in this case. If the hypothetical bond I described above is held to maturity, our investor will receive $1,000 plus $20 in interest payments for another four years. Assuming no change in interest rates, as maturity approaches the price of the bond should rise each year, resulting in an average annualized return of 5% through maturity.

Highest Rates in Over a Decade

While the speed of the increase in interest rates has resulted in temporary losses on many existing bonds, we believe higher rates are a resounding positive for long-term investors. We haven’t seen rates this high in Treasury and corporate markets in over a decade.
We are seeing intermediate-term corporate bonds with yields in the 4.5–6% range.

We recently purchased a three-year Southern Company bond for some clients at a yield to maturity of approximately 5.20%. Southern Company is one of the largest regulated utilities in the country. Southern owns and operates regulated utilities Alabama Power, Georgia Power, Mississippi Power, and Southern Power. Through its Southern Company Gas subsidiary, the utility also distributes natural gas through over 76,000 miles of pipeline to about 4.3 million customers in four states. Its energy sources include natural gas, coal, nuclear, and renewables. Southern bonds are rated Baa2/BBB.

Another bond we purchased recently for some clients is a Molson-Coors issue due in four years at a yield of approximately 5.35%. Molson Coors Beverage Company is one the world’s largest beer-makers by market value. The company has a diverse portfolio of beloved and iconic owned and partner brands, including Blue Moon, Coors Banquet, Coors Light, Miller High Life, Miller Genuine Draft, and Miller Lite. The bonds are rated Baa3/BBB-.

Increasing the Quality Component of Fixed Income

We recently boosted our clients’ exposure to Treasury securities. We owned a Treasury position for clients pre-COVID, and shortly after COVID began and yields on corporate bonds spiked higher, we sold Treasuries and moved into higher-yielding and lower-quality corporates. As the economic and credit cycles matured and Treasury yields moved up sharply, we have added to full-faith-and-credit-pledge Treasuries.

We own Treasury positions for most clients maturing in one, two, three, and six years. All four positions have yields to maturity of more than 4% today. We continue to favor shorter-term maturities overall as yields are higher than on longer-term bonds. As the economic cycle matures, we may decide to extend maturities.

One area of the Treasury market we have not yet moved into is Treasury inflation-protected securities (TIPS). TIPS are inflation-indexed bonds, which one might assume are the place to be with inflation raging; but TIPS are down almost as much as regular Treasury bonds YTD. The Bloomberg U.S. Treasury Inflation Linked Bond Index is down 13.37% compared to a 15.05% decline in the Bloomberg U.S. Treasury Total Return Index. Why are TIPS performing poorly in an inflationary environment? TIPS are an inflation hedge, but it is more accurate to say that TIPS are a hedge against unexpected inflation. When inflation began to rise last year, investors started to anticipate higher rates of inflation, and they factored that into the price of TIPS. The rise in interest rates this year has impacted the price of TIPS and normal Treasury bonds in a similar fashion. Higher rates equal lower prices.

We invested in TIPS in the past when we viewed the real rate as especially compelling. We may purchase TIPS again in the future if the yield rises to compelling levels or the inflation built into the price of TIPS falls to a level that is lower than we believe is reasonable.

A Lost Decade in Stocks?

I have been receiving questions about the possibility of stocks going nowhere for ten years. It’s difficult to accurately predict this given the abundance of unknown factors that markets will encounter: U.S. elections; monetary, fiscal, and tax policies; economic and business cycles; new technologies and medical breakthroughs; geopolitical events; black swan events, etc.

Regardless, investors are wise to prepare for long periods where the stock market does not appreciate. It’s not unheard of for stocks to lag for extended periods. This can be especially true for investors who lack proper diversification.

The chart below highlights the three secular bear markets for stocks over the last century. The dotcom bust is likely the most memorable to investors today. Those who concentrated their portfolios in new economy stocks in the late 1990s felt the most pain. It took the Nasdaq more than 17 years to surpass its dotcom high.

While it may be difficult to forecast a lost decade for stocks, what might one do to prepare for such an outcome?

First, diversify. If your entire portfolio is not in stocks, a lost decade will not impact you as much, and it may give you an opportunity to invest in stocks at more attractive levels following a correction. Bonds may have just had their lost decade, so the next ten years look better than the recent past.

Focusing on sectors of the market that offer value is also advisable. Long dry spells in the market tend to begin when valuations are stretched. Buying cheaper stocks is unlikely to eliminate all downside, but it may help you recover quicker. Our measure of value has long been focused on dividends. Dividend yield is an indicator of value, and the dividend record is often a signal of company strength. Firms that are short on cash flow rarely pay dividends. Dividends also have the added benefit of providing you with a stream of cash if equity prices remain stagnant for a long period of time.

Dividend Strategies Taking in Billions

As technology and innovation stocks struggled in 2022, dividend stocks came back in favor. Investors are putting billions into dividend funds. What took them so long to get dividend religion?

Inflation risk may be driving some of these flows. In inflationary periods, companies that pay dividends and increase those dividends may be able to provide investors with a hedge against inflation. The chart below shows the Consumer Price Index vs. Dividends Per Share for the S&P 500. Both series are set to 100 in 1950. Historically, dividend growth has outpaced inflation.

Our dividend strategy isn’t entirely focused on yield. A higher yield isn’t always a better yield. We want dividends today and higher dividends tomorrow. Firms that can pay sustainably rising dividends often have strong balance sheets, and they generate healthy cash flow that rises over time.

Have a good month. As always, please call us at (800) 843-7273 if your financial situation has changed or if you have questions about your investment portfolio.

Warm regards,

Matthew A. Young
President and Chief Executive Officer

P.S. At Richard C. Young & Co., Ltd., we seek to avoid the speculative elements in the market by pursuing a balanced investing approach. A mix of bonds, dividend-paying stocks, and precious metals has most often helped limit risk in our clients’ portfolios while delivering an acceptable return. A well-diversified balanced portfolio will probably never earn the highest return in any single year, but it is also unlikely to deliver the worst.

P.P.S. For stocks, we favor a globally diversified portfolio of companies that pay dividends and intend to raise them regularly. We favor established blue-chip-type holdings with durable businesses that have weathered a business cycle or two. We avoid startups and companies with unproven track records.
When it comes to dividends, we seek to balance dividend yield and dividend growth. We don’t chase income in the highest-yielding stocks. More often than not, dividends of the highest-yielding companies are at the greatest risk of being cut. We want an above-average dividend yield today and the prospect of a higher dividend tomorrow.

P.P.P.S. Writing for Behavioral Investment, Joe Wiggins observes: “During a bear market, it is hard to see anything ahead but unremitting negativity. Our tendency will be to believe that things will keep getting worse, prices will be lower again tomorrow. Our ability to make good, long-term decisions during a bear market is severely compromised. Rational thought will be overcome by the emotional strains we are likely to feel—what happens if things keep getting worse and I didn’t do anything about it?”
During volatile markets, patience is fundamental to achieving long-term investment success. The power of compound interest is not harnessed over weeks or months but over years and decades. Patience is also fundamental to investing in companies. Sometimes companies go through rough patches. As a shareholder, it can be frustrating to experience these periods, but a patient approach can be rewarded.

P.P.P.P.S. If you are considering when to start taking your social security benefits, you may be interested in Delaying Your Social Security Has Rarely Been This Profitable by Bloomberg’s Alexis Leondis. Several informative issues are raised: “… Even if you don’t collect benefits, the COLA adjustment—8.7% for 2023—still gets factored into the amount you’re eligible to receive starting at age 62. And it gets compounded, so each year you hold off on collecting to full retirement age (somewhere between 66 and 67 depending on when you were born) or beyond will make your eventual payout even juicier. The benefit increase stops when you reach age 70.”

P.P.P.P.P.S. Each year, Barron’s ranks the nation’s top independent advisors. Richard C. Young & Co., Ltd. has been recognized on this list for 11 consecutive years (2012–22).

* Rankings published by magazines, and others, generally base their selections exclusively on information prepared and/or submitted by the recognized advisor. Rankings are generally limited to participating advisors and should not be construed as a current or past endorsement of Richard C. Young & Co., Ltd. Barron’s is a trademark of Dow Jones & Company, Inc. All rights reserved.

September 2022 Client Letter

Here in Naples, we are already a month into the new school year. With our youngest son Jack now a freshman, we again have two kids in high school. Rick, a senior, has a study hall during first period, which allows him to stay at home until second period. This leaves me on morning-carpooling detail for Jack.

Jack and I leave the house around 6:40 a.m. Depending on the car line at Naples High, and on traffic, I am usually walking into the office by 7 a. m. After turning on the lights, I tune into Fox Business on the flat screen in our reception area. I listen to Maria Bartiromo for a few minutes to get a sense of what the national media is reporting about the global economy and financial markets.

Inflation, the Fed, and recession concerns have been much discussed this year. In April, Maria hosted a Harvard professor and former chief economist at the IMF for about a half hour. Typically, guests are on for less than a few minutes. He was pretty dour about the first-quarter GDP numbers, calling them “even below the worst” he imagined. He believed the chances of a recession to be 50-50 over the next year. More recently, a guest in the financial services industry told viewers that we are “technically in a recession.”

Recession

We are not yet convinced that the economy is in recession. The official arbiter of recessions in the U.S. is the National Bureau of Economic Research (NBER). NBER defines a recession as a significant decline in economic activity spread across the economy lasting for more than a few months. Factors the NBER uses to evaluate the economy include personal income, employment, consumer spending, and industrial production.

The NBER’s personal income measure is bordering on a new high. Employment is also at a high, and the labor market remains tight, with many more job openings than unemployed workers. Consumer spending remains relatively healthy, as does industrial production.

There are a couple of notable weak spots in the economy, including housing and some parts of the manufacturing economy, but perhaps we are simply seeing consumer demand shift from goods and houses to services as the pandemic economy subsides.

The recent ISM non-manufacturing survey on business seems to confirm this shift. The survey measures activity in the economy’s services sector. The July number improved from June and came in ahead of expectations. The details of the report appear to be positive. Business activity and new orders, two forward-looking components of the report, both increased to 59.9 from 56.1 and 55.6, respectively, in June. (Levels above 50 indicate expansion, and levels below indicate contraction.)

Dividends Can Provide a Cushion

Regardless of whether we are in a recession today or enter one in the future, a critical concept for investors to focus on is the fact that recessions end. During recessions, dividends are especially important because they can provide a cushion against falling stock prices. And, while waiting for the recession to end, dividends can be reinvested at lower share prices. 

Traditional safe-haven sectors during a recession include consumer staples, drug stocks, and utilities. Many firms in each sector sell goods or services that consumers and businesses continue to purchase regardless of the economic environment. All three sectors are well represented in our Retirement Compounders portfolios. Procter & Gamble, Johnson & Johnson (JNJ), and Southern Company currently represent our largest position in each sector. We believe it unlikely that consumers would stop purchasing Pampers diapers, Tide detergent, Bounty paper towels, or Gillette razors in a recession. Nor do we believe JNJ would realize a significant slowing in sales of its top drugs or medical products. And while Southern Company may see some decrease in electricity demand from its business clients, consumers will likely use about the same amount of electricity and natural gas as when the economy is booming.

Risk

When I first got into the investment business, my dad would tell me, “If you want to know someone’s risk tolerance, talk to them during a bear market.” Successful long-term investing is an equation involving both risks and returns. Too often, investors ignore risk. When times are good and a rising tide is lifting all ships, risk can become an afterthought. The fear of missing out can cloud one’s judgment.

WSJ columnist Andy Kessler recently wrote an article titled You’d Be Stupid Not to Evaluate Risk. Andy warns his readers to be sure to assess future risk and be aware of the promise of especially high yields and guaranteed returns that “you’d be stupid not to take.” He correctly points out that “Risk is often nebulous, hazy, unmeasurable—so it is usually ignored. Years of zero interest rates have caused havoc, but with the Federal Reserve raising short-term rates, investors should be extra careful shuffling money around.”

At Richard C. Young & Co., Ltd., we seek to avoid the more risky and speculative elements of investing by pursuing a balanced approach. A mix of bonds, dividend-paying stocks, and precious metals has most often helped limit risk in our client’s portfolios while delivering an acceptable return. A well-diversified balanced portfolio will probably never earn the highest return in any single year, but it is also unlikely to deliver the worst return. And, with risk reduced, it can be easier to ride out down markets.

Staying Invested

In my last letter, I included a bar chart titled Missing the Best Days Can Be Costly. The chart showed the potential missed opportunity to a portfolio’s value by sitting on the sidelines and missing market gains. I highlighted how Vanguard founder Jack Bogle did as much as anyone to help popularize the investing mindset of staying the course and not panicking during difficult times. In 1994, Bogle advised this in his book Bogle on Mutual Funds:

Think long-term. Do not let transitory changes in stock prices alter your investment program. There is a lot of noise in the daily volatility of the stock market, which too often is “a tale told by an idiot, full of sound and fury, signifying nothing.” Stocks may remain overvalued, or undervalued, for years. Patience and consistency are valuable assets for the intelligent investor. The best rule: stay the course.

A recent case in point to this advice is the markets’ runup since mid-June. Markets are up 10% in a short time. These are exactly the types of gains that you don’t want to miss.

Inflation

Inflation remains the focus of many market participants today. The trend in inflation sets the tone for the Federal Reserve’s interest rate policy, which helps determine prices in both the stock and bond markets. Higher-than-expected inflation this year has hurt both. While we expect inflation to moderate from current levels in the months ahead, it is not yet clear if a higher level of inflation than we’ve experienced over the last decade will persist over the medium term.

If Inflation Does End Up Settling In at a Higher Level, What Can Investors Do?

Number one: Be invested. One of the biggest mistakes individual investors make is not being invested. Retirement is expensive, especially when factoring in the constant effects of inflation—whether moderate or otherwise. Your dollars will only keep up with inflation if given a chance. They have no chance if they’re sitting in your checking account.

Number two: include assets in your portfolio that can help hedge against inflation. Real assets, including industrial commodities or gold, can hedge against inflation; but over the long run, so can stocks. We especially like dividend stocks for this purpose.

Companies that make regular annual dividend increases exceeding the rate of inflation are effectively providing you with an inflation-adjusted income stream.

In our view, on a risk/reward basis, dividend-paying stocks make a lot of sense. Many of the companies we own are ones we consider to be blue-chip, and they possess the characteristics necessary to ride out the business cycle. Dividend-payers can also provide comfort and peace of mind during difficult stock market environments, given their relatively reliable income streams.

Our goal is to buy companies we believe will hold their value for the long term. We do not buy based on what we expect to happen next month or next quarter. We also do not sell just because an industry or a particular company goes through a tough period.

Bonds

As interest rates rise, bond prices decline. As a result, it’s no surprise bonds have had a tough go this year. But it’s important to keep in mind that, except in the event of default, bond prices will gravitate upward, back toward par value as they approach maturity.

Also, because interest rates have increased, there have been more attractive yielding bonds for us to purchase during the last few months.

One of the bonds we purchased recently was an Apple issue with a 3.25% coupon rate due in seven years. With a AAA/AA+ credit rating, Apple has one of the highest ratings in the corporate bond market. We purchased the Apple bonds at a yield of approximately 3.25%.

Because interest rates have increased so rapidly this year, bonds with lower interest rates or coupons have much higher yields than the coupon rate implies. By example, we own a Waste Management bond for some clients. The bonds have a 1.50% coupon, and they are rated Baa1/A-. While the coupon is only 1.50%, the yield to maturity at current prices is 4.20%.

Speeding Toward Gridlock?

The 2022 midterm election is quickly approaching, and a divided Congress is a realistic possibility, with Republicans currently expected to take the House. Overall sentiment in the country appears to favor GOP candidates, with generic congressional ballots tight but currently favoring Republican candidates. The outcome of the races for positions in the Senate looks less encouraging for GOP candidates. Senate polls in battleground state races, including Pennsylvania, Georgia, Wisconsin, and Nevada, are not looking great for Republicans. Some early GOP targets for potential pickups in New Hampshire and Arizona are not looking so great either. Democrats are also outraising Republicans in key battleground races. The national mood could also shift, especially if voters associate Democratic Senate candidates with Joe Biden, whose polls are some of the worst ever at this point in the election cycle.

Divided Government

What happens next year if America finds itself with a divided government? One of the first things a divided government can accomplish is reducing government spending as a percentage of GDP. According to the Cato Institute’s Steven Hanke, “every instance of government shrinkage since World War II has occurred during a period of divided government.” But what about the stock market? According to a study by Bank of America Merrill Lynch, since 1936 the best stock market returns occurred under Democratic presidents with either complete or partial control of Congress by Republicans.

What Does a GOP House Mean for Taxes?

If Republicans are successful in taking the House, there could be a major shift in what taxpayers can expect from policymakers. In the past, Republicans have opposed Democrat priorities such as raising the regular income tax back to 39.6%, raising capital gains taxes, eliminating the step-up basis at death for investments’ cost basis, raising the corporate income tax, and raising the rate of taxation for carried interest.

Instead, the GOP has explained its plans for the tax code, which include:

• Making the 2017 tax reform (also known as the Trump tax cuts) permanent,
• Allowing for full and immediate expensing for investments in economic growth,
• Speeding up depreciation schedules for construction,
• Creating universal savings accounts,
• Raising the long-term capital gains tax bracket threshold to $75,000 to encourage investment among middle-income earners,
• Indexing capital gains taxes to inflation,
• Eliminating death taxes,
• Expanding net interest deductions,
• Reforming net operating loss deductions, and
• Introducing other measures to promote growth.

Many of these reforms are unlikely in a divided government, but their status as stated priorities for the GOP makes any tax increases seem unlikely.

Have a good month. As always, please call us at (800) 843-7273 if your financial situation has changed or if you have questions about your investment portfolio.

Warm regards,

Matthew A. Young
President and Chief Executive Officer

P.S. Some good news. Yields on money markets have been on the rise. Your Fidelity Money Market fund now yields 1.8%, up from nearly zero percent at the beginning of the year. If the Fed follows through with its forecast for interest rate increases this year, we could see money market yields reach 3% by year-end.

P.P.S. I-bonds have received attention recently. We have nothing against I-bonds, but it is important to keep in mind some of their features: There is a maximum purchase amount of $10,000 annually using cash and $15,000 if you use a portion of your tax refund. I-bonds earn interest for 30 years unless you redeem them first. You can redeem them after one year; but if you redeem them before five years, you lose the previous three months of interest. I-bonds must be purchased directly from the Treasury website or via your tax return. Interest on I-bonds is a combination of a fixed rate that stays the same for the life of the bond and an inflation rate that resets twice a year. This means that your interest upon purchase most likely will change in future years.

P.P.P.S. We are not gold bugs, which is the financial sector’s nickname for an investor who is perpetually and extremely bullish on gold. We like to have gold in portfolios as an insurance policy for when things go bad. But we also realize gold’s limitations at times and its tendency to behave oddly. Take this year by example. With all the negative headlines about war and inflation, one’s inclination could have been to load up on gold. But rising interest rates and the potential for a stronger dollar indicated to us that gold might face headwinds in 2022. So far, that has been the case. Gold is an inflation hedge, but it also competes with other assets. Higher interest rates and a stronger dollar tend to be negative for gold, while higher inflation tends to be positive. YTD, we are looking at a stalemate in how these factors influence the price of gold.

P.P.P.P.S. As part of the Inflation Reduction Act, the IRS will receive $80 billion to help fund 87,000 new workers. Before you get too concerned about an auditor knocking on your front door, consider this. The hiring is to include all positions at the IRS over the next decade. Like most businesses, the IRS employs numerous customer service reps and tech workers along with its agents. Additionally, over the next ten years, the IRS is expected to retire 50,000 workers. Lastly, as reported in the WSJ, “It will take time for the IRS to staff up, especially in a tight labor market. By one estimate, new agents aren’t fully productive for three to five years. The Treasury Department has pledged to use the new funding to focus on tax underpayments by higher-income people. Their returns are often more complex than lower earners’ returns, and the IRS needs to devise new audit methods.” If I had to guess, I bet most of you reading this pay your taxes, have few itemized deductions, and do not file complicated returns. You are most likely not a top priority for the taxman.   

P.P.P.P.P.S. Important Reminder – Fraudulent online activity continues to grow. Please remember to be vigilant in protecting your personal financial information. Please note, neither Richard C. Young & Co., Ltd. nor Fidelity Investments will ever send you a link (including via text message) asking you to verify the login information (username and password) to your financial account(s). Please contact us or Fidelity Investments immediately if you receive this type of request or if you believe your personal financial information may have been compromised. For your protection, we recommend that you implement multi-factor authentication for your online accounts. Other steps that you can take to protect yourself can be found at https://www.fidelity.com/security.

June 2022 Client Letter

My blood pressure readings were a little high at my annual physical in January. Not to the point where medication was required, but enough to schedule a June follow-up. My doctor suggested returning to a consistent exercise schedule. Between the end of 2021 and January of 2022, my exercise routine was disrupted due to travel and getting COVID. He felt getting back to my prior fitness habits would bring down my BP numbers.

Following doctors’ orders, I got back at it. Between my annual physical and the June follow-up, not a week went by where I did not exercise at least three days. Heading into the June appointment, I accumulated 57 consecutive daily workouts. While several of the workouts were wimpy, for the most part, I took things seriously. I now have newfound muscles, and when in race mode on the Peloton, I can finish in the top 5% of all riders.

My doctor is approximately 10 years older than me. He, like me, has a daughter and two sons. He is also one of the more physically fit people I know. For these reasons, I use him as my health and wellness benchmark. He also has given me one of my favorite pieces of health advice, telling me the decisions I make in my 50s will set the stage for life in my 60s.

This advice plays well in many areas of life. Decisions made today can set the stage for a successful future.

One important decision we make for clients is focusing on what we feel to be the “blue-chip” area of the stock market. Sectors including consumer staples, health care, and utilities can hold up relatively well when stock market volatility is high. We also tend to eschew the more faddish segments of the market. Over the past several years, there has been a lot of excitement in meme stocks and cryptocurrencies. But these types of investments tend to be speculative in nature versus what we would consider an investment. In our view, a healthy portfolio has limited exposure to speculation. Instead, it concentrates on companies dominant in their industries, with real cash-flow generation, and those that seek to raise their dividends annually.

Jamie Dimon Calling an Economic Hurricane 

Jamie Dimon, chair and CEO of JPMorgan Chase, recently unleashed an economic forecast that caught people’s attention:

“You know, I said there’s storm clouds but I’m going to change it … it’s a hurricane,” Dimon said Wednesday at a financial conference in New York. “While conditions seem ‘fine’ at the moment, nobody knows if the hurricane is a minor one or Superstorm Sandy,” he added.

“You’d better brace yourself,” Dimon told the roomful of analysts and investors. “JPMorgan is bracing ourselves and we’re going to be very conservative with our balance sheet.”

 Why Staying the Course Makes Sense 

Typically, during problematic environments, staying the course is a prudent investment decision. Vanguard founder Jack Bogle did as much as anyone to help popularize the investing mindset of staying the course and not panicking during difficult times. In 1994, Bogle advised this in his book Bogle on Mutual Funds:

Think long-term. Do not let transitory changes in stock prices alter your investment program. There is a lot of noise in the daily volatility of the stock market, which too often is “a tale told by an idiot, full of sound and fury, signifying nothing.” Stocks may remain overvalued, or undervalued, for years. Patience and consistency are valuable assets for the intelligent investor. The best rule: stay the course.

It can be tempting to try to get out of the market ahead of an economic hurricane and get back in when markets have bottomed, but in practice, this is often a loser’s game. No one sounds a siren at the top of the market or rings a bell at the bottom telling you when to place your trades. Properly timing the market means selling when everyone else is convinced the party will never end and buying back in when the doomsday economic headlines are on the front page of the newspaper. And, even if you get things broadly right, you might still have been better off staying the course.

The chart below shows the risk of missing out on the market’s best days. Starting in January of 1990, if you invested $10,000 in the S&P 500 and kept it there, you’d have over $200,000 today. If you missed the 10 best days in the market, you’d have about half as much, and if you missed the best 50 days, your portfolio would be worth about a tenth of the value of the buy-and-hold investor’s portfolio.

Staying the Course Can Be Easier Said Than Done

If you have a portfolio full of more speculative securities, then the emotional hurdle of staying the course becomes harder. Chasing hot newer industries can have unpleasant consequences. I wrote about this in my December 2021 letter:

We believe Tesla is a largely speculative bet on a possible future that implies that something close to a winner-take-all situation will arise in the fiercely competitive auto industry. The company is worth more than the combined value of almost all legacy auto manufacturers. This is true despite the fact that Tesla is only projected to sell approximately 890,000 vehicles in 2021. In a normal year, the global market is a 90-million-unit industry. That’s about a 1% market share for Tesla, the world’s most valuable auto producer. We believe that the assumptions investors are making to justify Tesla’s nearly $1-trillion current market value are simply implausible.

New industries can generate overexcitement and unrealistic expectations. Money pours into the dream that the new player will dominate the market in the years ahead. Investors ignore the lack of profits and the high amount of cash that companies burn through to get their businesses established. Then, when things turn south, their stocks really take a beating and may not even survive. The Wall Street Journal recently summed up this risk for EV startups:

While the rising cost of capital is hitting speculative stocks in other sectors too, EV startups have more to lose than most. Launching a new car maker is extraordinarily expensive, and the costs come years before the profits. Bridging this gap is much easier if money is essentially free, as was the case with the influx of cash from special-purpose acquisition companies last year. Those days are fading fast.

A Balanced Approach

At Richard C. Young & Co., Ltd., we seek to avoid the speculative elements in the market by pursuing a balanced investing approach. A mix of bonds, dividend-paying stocks, and precious metals has most often helped limit risk in our clients’ portfolios while delivering an acceptable return. A well-diversified balanced portfolio will probably never earn the highest return in any single year, but it is also unlikely to deliver the worst return.

Avoiding Speculation with Global Dividend-Payers

For stocks, we favor a globally diversified portfolio of companies that pay dividends and intend to raise them regularly. We favor established blue-chip-type holdings with durable businesses that have weathered a business cycle or two. We avoid startups and companies with unproven track records.

When it comes to dividends, we seek to balance dividend yield and dividend growth. We don’t chase income in the highest-yielding stocks. More often than not, dividends of the highest-yielding companies are at the greatest risk of being cut. We want an above-average dividend yield today and the prospect of a higher dividend tomorrow.

During the current bear market, dividend-paying stocks are down; but they are down much less than the broader market. Higher-dividend payers have been among the best-performing stocks in the market this year. A greater weighting in energy and consumer staples shares has helped in the current environment.

While it’s nice for the stocks we buy to be in favor, it isn’t the core goal of our Retirement Compounders strategy. We take a very long-term perspective focused on limiting volatility and compounding growth. It is possible that RCs-type stocks could remain in favor for years, or they could fall out of favor in a matter of months. If we are buying companies that pay a decent dividend today and we have confidence the dividend will increase over time, we can remain patient while the power of compounding takes over. If the market’s opinion of your portfolio is concerning to you, just remember Bogle’s view on the market: “a tale told by an idiot, full of sound and fury, signifying nothing.”

 Beware of the Headlines

Sometimes it’s best not to pay too much attention to the headlines of the day. There are many questionable headlines, blogs, and emails highlighting stories or trends that do not pan out.

For example, not even two years ago, Zoom, the video conferencing software company, was worth more than ExxonMobil. Negative oil futures prices, combined with a belief that oil and natural gas would become worthless, soured sentiment on Exxon shares, and the pandemic boom in video-conferencing software made Zoom’s rise seem unstoppable.

CNN helped fuel the soured sentiment on Exxon with an article explaining that the world would never recover its thirst for oil:

All this could mean that global demand never returns to its 2019 record high, a scary prospect for oil companies and their employees from Texas to Western Europe, and countries such as Russia, Nigeria, or Iraq that depend heavily on selling crude.

“I think the pressure to accelerate the forces driving the energy transition will only increase as a result of this crisis,” said Mark Lewis, global head of sustainability research at BNP Paribas Asset Management in Paris.

CNN’s reporting from that time seems ridiculous, as does the fact that one of the world’s largest producers of a resource vital to the health of the global economy would be worth less than a company that sells a product with big established competitors offering the same thing for free. 

Recent developments and policies do not necessarily mark the beginning of a new trend or the end of a current industry. The establishment of hostile government policies toward fossil fuel companies does not mean conventional energy stocks are bad investments. As an old-hand value investor, Bill Smead said in Barron’s: “I was 10 years old when the U.S. government banned tobacco ads on television. Guess what was the best-performing stock on the New York Stock Exchange over the next 40 years? Philip Morris [PM].”

Have a good month. As always, please call us at (800) 843-7273 if your financial situation has changed or if you have questions about your investment portfolio.

Warm regards,

Matthew A. Young
President and Chief Executive Officer

P.S. President Reagan said, “The nine most terrifying words in the English language are: I’m from the government, and I’m here to help.” Joe Biden is here to help with gasoline prices. As if policies preventing drilling in certain regions and making it more costly and difficult to produce oil and gas haven’t helped enough already. Now Biden is telling refining companies they need to produce more gas. Look for taxes and price controls next. Neither help. They simply limit future supply.

P.P.S. Writing for Behavioural Investment, Joe Wiggins observes: “During a bear market, it is hard to see anything ahead but unremitting negativity. Our tendency will be to believe that things will keep getting worse—prices will be lower again tomorrow. Our ability to make good, long-term decisions during a bear market is severely compromised. Rational thought will be overcome by the emotional strains we are likely to feel—what happens if things keep getting worse and I didn’t do anything about it?”

During volatile markets, patience is fundamental to achieving long-term investment success. The power of compound interest is not harnessed over weeks or months but over years and decades. Patience is also fundamental to investing in companies. Sometimes companies go through rough patches. As a shareholder, it can be frustrating to experience these periods, but a patient approach can be rewarded.

P.P.P.S. Heading into the last bond-market downturn, we had a meaningful allocation to full-faith-and-credit-pledge Treasury notes. When COVID started, and yields on corporate bonds soared, we sold our clients’ Treasury notes and purchased higher-yielding corporate bonds. Until recently, we have focused on corporate bonds; Treasury yields were simply too low.  

Given how much rates have risen, we are again purchasing Treasury securities. Yields are relatively attractive, and with some concerns about a recession or Jamie Dimon’s economic hurricane, it seems prudent to us to reintroduce this asset class back into portfolios.

P.P.P.P.S. The Silver Lining in the bonds. The good news is that you have survived the worst bond market in a generation. The fixed-income portfolios we manage for clients are down less than the broader bond market after taking into account our intentional overweighting in cash and some shorter-maturity high-yield bonds and loans, but they are still down.  

It is also important to keep in mind that, except in the event of default, bond prices will gravitate upward, back toward par value as they approach their maturity date. There is no such force acting on stocks. Excessive valuations or a new earnings growth trajectory can lead to what is effectively a permanent loss on individual stock positions. That is not to say that yields won’t continue to rise; but we anticipate the pace of increase to be slow, providing time for interest income to accumulate and lessen the blow of any further decline in prices.

May 2022 Client Letter

Recently, our family began the process of touring colleges for my son, Rick, who is finishing his junior year at Naples High. On our first round of visits, we flew Delta, connecting in Atlanta and finally arriving in Charlottesville. After a tour of the university and a stop at Monticello, we drove Route 29 to Chapel Hill, where we stayed a few nights before heading home from Raleigh-Durham. The following weekend we had a direct flight on Southwest for a quick 24 hours in Nashville.

I have been on a plane many times since COVID began. Mostly to bring my daughter to school in Tuscaloosa and for visits back home to Newport, RI. Traveling during that time was relatively pleasant. It was simple to book flights—sometimes the middle aisle was purposely left vacant—and crowds were thin. Best of all, airfares were relatively cheap.

Now, all of that appears to be over. Our flights were full during the college trips, and the airports were busy. If you are looking to find a cheap flight these days, good luck. A combination of robust demand for air travel and a significant increase in jet-fuel costs means cheaper tickets are tougher to find.

According to Delta this past April, “There are clear signs of pent-up demand for travel and experiences as consumers’ spending shifts from goods to services and experiences, travel restrictions lift, and business travelers continue to return to the skies.”

American Express conveyed a similar view, stating, “[Travel & Entertainment] T&E spending did show a dip in January, and early February due to the Omicron variant, but spending then rebounded tremendously, reflecting pent-up travel demand and essentially reached 2019 levels for the first time since the start of the pandemic in the month of March. And this kind of T&E spending growth has continued right into early April.”

As you are aware, not just travel has become more expensive. Prices have risen on many things we regularly buy. Heading into 2022, inflation was viewed as one of the biggest risks for investors. And while the Fed has begun to raise interest rates, I do not believe the inflation concern is less now than in January.

Investors focus on several factors when looking to protect themselves from inflation. Obviously, energy is viewed as a solid hedge and has not disappointed this year. The sector is up 48% YTD and is ahead of every other sector in the S&P 500 by a mile. Today’s higher prices are allowing energy companies to pay off debt and raise dividends. Energy companies in our portfolios, including Chevron, Exxon, Phillips, Valero, Williams, and Kinder Morgan, have all benefited. As a bonus to this year’s significant returns, the average dividend yield of this group is approximately 4%.

The Charm of Boring Stocks

Another sector viewed favorably during inflationary periods is the stodgy consumer-staples sector. Due to a combination of inflation concerns and market volatility, investors have been allocating money into consumer staples stocks along with other defensive sectors. As the WSJ reported on May 2, “Investors are rediscovering the charms of boring stocks. Investors appear to be turning their focus to companies offering everyday necessities—a preference that has been amplified as many such companies post strong quarterly results. The consumer-staples group was the sole S&P 500 sector in the green for April, with a gain of 2.4%. With U.S. inflation at a four-decade high, investors are keeping a close eye on how companies are holding down their costs or passing increases along to customers through higher prices. Reports from some consumer-staples companies suggest households have yet to flinch at higher prices for basic items.”

Consumer staples shares have long been one of our favored groups. Why? For starters, the dampened cyclicality of the sector provides a greater degree of confidence in the long-term prospects of firms in the space. Many companies in the staples sector are durable businesses with long operating histories and formidable brand portfolios.

What startup will outspend P&G to gain market share in diapers or detergent? Or, when is the last time you saw a new candy bar not created by one of the big incumbents gain a foothold on store shelves? The barriers to entry in the branded consumer goods industry are significant.

The trade-off for investing in high-quality businesses such as P&G or Hershey is that they don’t tend to keep pace with the more speculative end of the market when investors’ risk appetite is high. By example, you can see in the chart below that until recently, consumer staples stocks trailed the more speculative NASDAQ Composite by a meaningful margin in the current bull market.

The performance gap started to narrow in November of last year. Since that time, the NASDAQ has fallen sharply while consumer-staples stocks have continued to plod along. As of this writing, the Consumer Staples Index and the NASDAQ returns from the 2020 bear-market lows are within a couple of percentage points of each other. The distinction to make is that to earn a similar return, investors in staples stocks took on less risk than investors in the NASDAQ.

Consumer staples stocks, and reliable dividend payers in general, are rarely as sexy as the newest technology firms in the NASDAQ; but when you are in the business of long-term compounding, boring, routine, and dull are desirable.

Hot New Investment Theme… But Not for Us

It has been a while since we could say this, but the broader investing public looks to be coming back around to our way of thinking on dividend investing. As Barron’s put it in a recent feature, “The hot new investment theme isn’t socially nuanced crypto space finance or metaverse charging networks for virtual vehicles. It’s dividends—cash payments to shareholders.”

According to strategists at BofA Securities, the S&P 500 is poised for minimal price returns from here, and dividends could make a big difference in terms of total return. BofA notes that since 1936, dividends have made up more than one-third of total returns. When you factor in the reinvestment of dividends, you find that dividends and reinvested dividends have accounted for close to half of the total return on stocks over the last 30 years.

Regular Dividend Increases Are Key

Throughout the year, your monthly brokerage statement shows the dividends paid into your account. When viewed individually, these payments may not appear as large numbers. But when added up for an entire year, you will most likely be pleased with the final figure.

We seek companies with track records of making annual dividend increases. Typically, these increases are in the single-digit percentage range. As time passes, these annual increases have a big impact on the dividends you receive.

As an example, let’s take a hypothetical portfolio with $1 million invested in dividend-payers. Assume a starting yield of 3% and annual dividend growth of 6%. After 20 years, that initial $30,000 in dividend income will have increased to $96,214. After 30 years, this hypothetical portfolio would generate $173,305 in annual dividend income, which doesn’t include the additional dividend income that would be generated by reinvesting dividends.

Bond Market Suffering Worst Period in Decades

In early May, the bond market hit a new milestone, with the 10-year Treasury reaching 3% for only the third time since 2011. Prior stays above 3% were brief. The rise in longer-term yields to 3% represents a 90% increase from 10-year yields at the start of the year. The four-month return on the most widely cited bond index (Bloomberg Aggregate) for the period ending in April was the worst on record, going back almost 50 years.

Many investors anticipated a rise in interest rates this year, but longer rates have moved much faster than many expected. The significant rise in longer rates has pushed the value of bonds down during the same period that stocks have also been falling.

The Silver Lining in the Bond Market

The good news is that you have survived the worst bond market in a generation. The fixed-income portfolios we manage for clients are down less than the broader bond market after taking into account our intentional overweighting in cash and some shorter maturity high-yield bonds and loans, but they are still down.

While disappointing that bonds are down at the same time as stocks, it is important to keep in mind that bonds are not like stocks. Projecting the past five months of returns into the future could be a mistake. A 90% rise in yields from current levels brings the 10-year Treasury yield to nearly 6%. Ten-year Treasury yields haven’t been near 6% in over 20 years.

It is also important to keep in mind that, except in the event of default, bond prices will gravitate upward, back toward par value as they approach their maturity date. There is no such force acting on stocks. Excessive valuations or a new earnings growth trajectory can lead to what is effectively a permanent loss on individual stock positions.

That is not to say that yields won’t continue to rise, but we anticipate the pace of increase to slow, providing time for interest income to accumulate and lessen the blow of any further decline in prices.

And while stock and bond prices have moved in tandem so far this year, if the Federal Reserve pushes interest rates to a level sufficient to increase the likelihood of recession, we expect bonds’ traditional counterbalancing role to reassert itself in portfolios.

4%-Plus Yields in Corporate Bonds

The upshot of poor bond performance this year is that interest rates on investment-grade corporate bonds are at levels that offer the prospect of decent interest income over coming years. We recently purchased a Constellation Brands bond due in 5 years at a yield of 4.35%. Constellation is a leading wine, beer, and spirits company. Brands include Mondavi and Corona Extra. We also purchased a Clorox bond with a slightly longer maturity at a yield of 4.4%.

After too many years of being punished by a 0% interest rate policy, income investors and those in or nearing retirement can now earn a decent stream of interest income without taking undue risk.

Have a good month. As always, please call us at (800) 843-7273 if your financial situation has changed or if you have questions about your investment portfolio.

Warm regards,

Matthew A. Young
President and Chief Executive Officer

P.S. In NFT Sales Are Flatlining, the WSJ reports, “The sale of nonfungible tokens, or NFTs, fell to a daily average of about 19,000 this week, a 92% decline from a peak of about 225,000 in September, according to the data website NonFungible. The number of active wallets in the NFT market fell 88% to about 14,000 last week from a high of 119,000 in November. NFTs are bitcoin-like digital tokens that act like a certificate of ownership that live on a blockchain. Rising interest rates have crushed risky bets across the financial markets—and NFTs are among the most speculative. Many NFT owners are finding their investments are worth significantly less than when they bought them.”

A few important takeaways from this article can help you maintain a steady course toward long-term investment success. First, new technologies that offer profound promise are not always profitable investments. Maybe things don’t pan out as expected, or maybe they do. In the latter case, often the hype cycle of the latest and greatest leads to prices or valuations that can never be lived up to. You should evaluate what you can lose on any potential investment before you think about what you can make. Be comfortable with the loss you would incur if things don’t pan out. Size your position accordingly. Finally, don’t forget that sentiment can change swiftly and without notice. The NFT market was booming last year. Beeple sold a piece of digital art for $69 million in 2021. The value of the Bored Apes and the Crypto Punks shot up into the millions. Now interest seems to be waning. Will it reverse again? Probably. Will NFT values shoot back up if sentiment improves? Maybe is our best estimate, and maybe is not how you compound wealth.

P.P.S. I’m surprised I’ve not seen this quote before because it’s right up our alley. It’s from money manager, author, and Warren Buffett–follower Mohnish Pabrai: “You don’t make money when you buy stocks. And you don’t make money when you sell stocks. You make money by waiting.”

P.P.P.S. Today’s financial headlines are dominated by inflation, interest rates, supply chains, and Russia. But as the year rolls on, increased attention will be paid to the midterm congressional elections. As of now, it appears the Republicans will pick up a significant number of seats, which would deliver an even more divided government in Washington D.C. Political gridlock is often a situation the markets favor.

Here in Florida, Alex Roarty and Bianca Padró Ocasio report in the Miami Herald on a new worry among Democrats:

Liberal grassroots groups in Florida are reducing staff and scaling back voter-outreach efforts because of a growing reluctance from out-of-state donors to spend money on the state, say top progressive strategists.

If the financial pullback continues, they warn, it threatens not only the party’s chances in this year’s slate of midterm races but also Florida’s place as a top-tier battleground in the 2024 presidential election…

Concerns about Democrats’ competitiveness in Florida have festered on the left ever since former President Donald Trump’s victory here in 2016. But liberal strategists say that, while it’s not too late to turn things around, what they’re seeing now makes them concerned that Florida is entering a dangerous new phase, in which the failure of past elections saps resources for future races and makes winning even harder—pushing the party into a kind of death spiral here that could turn a former swing state into one Republicans dominate for a generation.

P.P.P.P.S. I have been asked why gold prices have not risen more, given the higher degree of volatility and uncertainty. Many factors tend to influence the price of gold, including these most important ones: interest rates, inflation, and the value of the U.S. dollar. Gold also reacts positively to geopolitical flare-ups, but this tends to be a more fleeting source of price fluctuation. Rising inflation is often positive for gold, while rising interest rates are negative for gold. A stronger dollar is often negative for gold as well. If we build a simple model of gold prices that uses the dollar, inflation, and real interest rates (since we already accounted for inflation), gold is trading right where we would expect. Inflation is helping to boost gold prices, while a strong dollar and higher interest rates (in real terms) are pushing it down. The net-net is that gold is about flat YTD. Exclude inflation from the model, and gold might be 20% to 30% lower than it is today.

March 2022 Client Letter

Fortunately for me, the worst part of getting COVID-19 was the effect it had on my fitness program. As I wrote in my last letter to you, I have been exercising consistently since my Peloton bike arrived in April 2021. But a combination of unexpected travel and a mild form of the virus led me to miss many weeks of workouts. 

When I finally got back into the saddle, my absence from my near-daily workouts was shockingly noticeable. On the first ride, it was evident my body was out of sync and not happy to be peddling. The Peloton data display allows riders to compare current workout metrics to past metrics. My post-COVID numbers were way off; and, since returning to the bike, I am still nowhere near where I was previously.

I observed a few things since getting back into an exercise routine: 1) Before COVID I was in much better shape than I had given myself credit for. 2) I now understand why I was in such good shape: It wasn’t from working out for hours each day at maximum effort or intensity. It was simply that for months, from April into December, I was exercising daily. Aided by the Peloton suite of fitness offerings, I not only biked but also mixed in their strength, stretch, and foam rolling classes. Even when short on time or not feeling motivated, I would do at least a 10-minute workout which, in my book, counts toward daily exercise. The consistency of my efforts had really begun to pay off.

Consistency can also be used as part of a successful investment strategy.

Dividend Consistency

Our Retirement Compounders® (RCs) equity program targets consistent dividend-payers. The longer the record of regular dividend payments, the better. Companies that have paid consistent dividends through numerous economic expansions and contractions are often quality businesses.

In the RCs, we favor firms with consistent records of paying regular dividends, but we also like firms that have consistently increased annual dividends. A growing stream of dividend income can solve a lot of problems for investors.

How Dividend Stocks Can Help You

For starters, and especially topical today, dividend growth can help offset the impact of inflation on the purchasing power of your retirement portfolio. Companies that pay meaningful dividends and raise those dividends over time also provide a more meaningful foundation for long-term capital appreciation. What do I mean by meaningful? Consider a non-dividend-payer whose price has risen because investors believe the firm’s prospects have improved. Zoom circa early 2020 comes to mind as an illustrative example.

In February of 2020, a share of  Zoom could be purchased for $105. To put some context around the price, at $105 per share, Zoom was trading for 25X sales. Sales for the prior 12 months were $622 million. Historically, a 25X sales multiple indicates investors anticipate significant growth in the future.

The pandemic hit in March, and lockdowns started soon after. Zoom’s business boomed. The share price rocketed upward to $470 by September of 2020. At $470 per share, Zoom was trading at 97X sales, which had increased to $1.6 billion. If investors anticipated rapid growth in February, expectations were off the charts by September.  

Today, Zoom does annual sales of $4 billion. That is more than six times the sales number from February of 2020. A six-fold increase in sales in two years is an impressive feat. The problem for Zoom investors is that sentiment on the company’s future prospects has cratered. As of this writing, Zoom shares are trading at $99 per share, which equates to “only” 7X sales. Despite a truly colossal increase in sales, shareholders are 6% poorer today than they were two years ago.

Contrast a company like Zoom with a hypothetical dividend-payer. I’ll keep the arithmetic simple for illustrative purposes. Assume a starting share price of $100, an annual dividend of $3, and a dividend growth rate of 7.2%. At 7.2% growth, the dividend will double in 10 years. To maintain a 3% yield in 10 years, the share price would also have to double. A cold hard stream of cash you can deposit in the bank provides a more meaningful foundation for capital appreciation than an increase in sales that is more of an abstract concept to shareholders.

Dividend Stocks Tend to Fall Less in Bear Markets

What other problems can dividend stocks help investors solve? Bear markets aren’t fun for anybody. This is especially true for those in or nearing retirement. Retired investors may rely on their portfolios for income, and those nearing retirement simply don’t have as much time to make back the losses. While not a cure-all, stocks with a consistent record of paying and increasing dividends tend to fall less in bear markets than do non-dividend-payers. Why? Not only are companies that consistently pay and increase their dividends most often more stable and cash-generating, but when prices fall, a reliable dividend can provide a floor under the price as yields rise.

Dividend consistency is comforting during periods of market volatility like we have today. The current bout of volatility has been wicked for non-dividend-payers and high-growth/technology companies. You may recall from previous letters that technology shares have come to dominate the S&P 500. Apple, Amazon, Google, Facebook, Microsoft, Nvidia, and Tesla are among the ten largest stocks in the index.

The Big Bust in High-Growth/Technology Stocks

The table below lists some of the more recognizable high-growth technology companies that are among the worst 10 performers in the S&P 500 YTD.

If you broaden the list to include the 1,000 largest companies as measured by the Russell 1000 index, you see carnage in high-growth names rivaling the dotcom bust. The list below shows how much each company is down from its all-time-high price reached within the last two years. 

Stodgy Dividend-Payers Fine in Relative Terms

How have stodgy dividend-paying companies performed during the current stock market correction? The average dividend-paying stock in the S&P 500 is down 5% YTD compared to a 19% loss for the average non-dividend-payer. And the S&P 500 High Dividend Index is up 1.4% on the year compared to a loss of 12.2% for the S&P 500.

As inflation has picked up and the price of money risen, companies with potential payoffs far into the future have fallen out of favor with investors. Stocks that generate a steady stream of cash for compounding, and those in industries such as energy that benefit when inflation rises, are back in favor.

Three New International Dividend Stocks

We, of course, continue to pursue our dividend strategy regardless of sentiment toward the businesses we favor. In some RCs portfolios, we recently added new positions in Legal & General, Bridgestone, and Universal Music. All three companies are international businesses. We continue to see long-term value in international shares, as there has been a relative lack of excitement in this sector compared to U.S. stocks.

Legal & General

Established in 1836, Legal & General is one of the UK’s leading financial services groups. With almost £1.3 trillion in total assets under management, L&G is the largest investment manager for corporate pensions in the UK and a UK market leader in pension risk transfer, life insurance, workplace pensions, and retirement income. The pension risk transfer business (PRT) has appeal, in our view. Compared to other insurance lines of business, PRT has higher initial capital costs and higher barriers to entry. Businesses that are offloading the management of their pension plans to a third party won’t pick just any investment manager. New entrants are at a distinct disadvantage to incumbents. Legal & General pays a generous dividend that yields 6%. The company also seeks to increase its dividend at a 3%-to-6% average annual rate over the medium term.

Bridgestone

Based in Japan, Bridgestone is one of the largest tire manufacturing companies in the world. Bridgestone operates in over 150 countries and sells new and replacement tires as well as other rubber-associated products. The global transition to EVs is expected to increase the demand for tires, as the additional weight and torque of EVs will likely mean quicker wear and tear. Bridgestone has the best balance sheet in the industry, which can be an advantage during cyclical downturns. The shares trade at what we believe is an attractive level. What’s more, the stock yields almost 4%.

Universal Music Group

Universal Music Group (UMG) is the premier music label in the world. The company represents many of the top recording artists, including Taylor Swift, Queen, the Beatles, the Rolling Stones, James Brown, Jonny Cash, and Carrie Underwood. Universal’s labels own rights and royalties to about a third of the “music catalog,” essentially all economically relevant music. We love the nature of the royalties and consider them among the best an investor can own. Unlike video, music is listened to over and over, with labels effectively earning royalties each time the music is played. What’s more, copyrights last for decades— in many cases for 70 years from the death of the author. Universal shares yield about 2%, and we are looking for double-digit dividend growth.

AT&T’s Dividend Reset

In the coming months, AT&T will spin off its Warner Media business, which will then merge with Discovery. The combined company will be a formidable competitor in streaming. As a result of the spin-off, AT&T has decided to reset its dividend. The new dividend equates to a yield of 4.84% based on the company’s current share price. AT&T will remain one of the highest-yielding stocks in the S&P 500. While the dividend reset is a disappointment, it was necessary in considering the spin-off and should provide the foundation for faster dividend growth moving forward. The unfortunate reality is that AT&T was not being rewarded by investors for its high-dividend yield and past dividend increases.

Fixed-Income Portfolio Strategy

We recently purchased two 10-year maturity bonds. One was issued by Starbucks and the other by Union Pacific. The Starbucks bond was purchased at a yield of approximately 3% and the Union Pacific bond at a yield of approximately 2.85%. Both bonds have investment-grade ratings of Baa1/A-.

With interest rates on the rise, some investors may wonder if purchasing a 10-year bond makes sense. Headlines in the financial press warning about a bond bubble certainly don’t help set bond investors at ease.

It is important to keep in mind that we are crafting an entire fixed-income portfolio. While a portfolio comprised exclusively of 10-year bonds may have too much interest-rate risk, a portfolio of short, intermediate, and longer-term bonds is likely less sensitive to rising interest rates. This is true for the fixed-income portfolios that we manage for you. The individual bonds we purchase are only one component of the portfolios.

Today we are holding a higher than normal cash allocation, which helps to lower the interest rate risk of your fixed-income portfolio. In fact, so far this year, cash has been the best performing component of the fixed-income portfolios we manage. 

In addition to the investment-grade bonds like Starbucks and Union Pacific that we purchase in fixed-income portfolios, we also hold the Fidelity Floating Rate Fund and the iShares Broad U.S. High-Yield ETF (USHY). The Fidelity Floating Rate fund invests in floating-rate loans with a duration close to zero. The high-yield-bond ETF we own has an intermediate-term duration. Both tend to perform well when the economy is strong and interest rates are more likely to rise.

Less Than Half the Interest Rate Risk

Overall, when you factor in the cash, the range of maturities of the investment-grade bonds, and the lower-grade bond funds, our clients’ portfolios have less than half of the interest-rate risk of the most popular broad-based bond indices.  

Preparation and Planning Make Volatility an Opportunity

The first meaningful stock-market correction in almost two years can be unsettling for investors who have become accustomed to markets moving in only one direction. The headlines are concerning, as they often are when stocks are falling; but with proper preparation and planning, volatility can be welcomed as an opportunity.

When we help you craft a portfolio that is best aligned with your goals and objectives, we account for corrections, bear markets, inflationary periods, deflationary periods, recessions, and many other factors. It may not seem like it when markets are in free fall, but this was part of the plan. The reason you may have a more conservative strategy than some of our other clients is because you are either unwilling or unable (due to income needs, shorter time-horizon, etc.) to tolerate a significant downside. That doesn’t mean no downside. Every investment strategy outside of T-bills can be expected to fall in value at some point. Successful investing is about aligning your portfolio with your goals and objectives and then not allowing emotionalism to get the better of you when market turbulence inevitably hits.  

Have a good month. As always, please call us at (800) 843-7273 if your financial situation has changed or if you have questions about your investment portfolio.

Warm Regards,

Matthew A. Young
President and Chief Executive Officer

P.S. At their low, the energy companies in the S&P 500 that produce oil and gas to fuel America’s auto fleet and keep the electricity running accounted for 1.9% of the market value of the index. At the same time, Facebook accounted for 2.4% of the index’s market value. When one social media company is worth more than an entire sector as vital as energy, something is out of whack. In the Retirement Compounders, energy shares have long been a meaningful allocation. That didn’t help performance when nobody wanted to touch energy stocks and oil futures were trading at a negative price, but it is helping today. We do not try to mirror the S&P 500 or any other index. We favor certain energy companies, in part, due to their attractive dividends and their tendency to keep pace with inflation.

P.P.S. Gold is often seen as an investment that can protect against inflation, but it is also viewed as a hedge against chaos and troublesome global events. Gold has lived up to its chaos hedge brand as geopolitical tensions flare with Russia invading Ukraine. Gold is up 7% YTD, while stocks and bonds are both down. There are many ways to invest in gold and many different gold funds to choose from. We favor gold ETFs that invest directly in the metal as opposed to gold mining companies. Gold miners can provide significant leverage to the price of gold, but that leverage cuts both ways, and gold miners come with additional risks: operating risk, hedging risk, financial risk, and nationalization risk. But even after you narrow your options down to ETFs that hold physical gold, there are still at least 10 to choose from. For new money, we favor the SPDR Gold MiniShares (GLDM) ETF. GLDM is a lower-cost and lower-priced alternative to SPDR Gold Shares (GLD). We still hold GLD for many clients who own the position at a large unrealized gain, but in all tax-deferred accounts and for new accounts, we buy GLDM. We favor GLDM for liquidity and cost. GLDM has $5 billion in assets under management and trades about 5 million shares per day. Not the most volume, but plenty to establish a position meant to be held for the long term. After a recent fee cut and reverse stock split, GLDM is now the lowest-expense-ratio physical-gold ETF, and it has the second-lowest transaction costs of all gold ETFs.

P.P.P.S. We recently updated both Part 2A and Part 2B of our Form ADV as part of our annual filing with the SEC. This document provides information about the qualifications and business practices of Richard C. Young & Co., Ltd. If you would like a free copy of the updated document, please contact us at (401) 849-2137 or email cstack@younginvestments.com. Since the document was last updated in March 2021 there have been no material changes.

December 2021 Client Letter

When I turned 50, my mom offered to buy me a Peloton bike. Initially, I was hesitant to accept the gift. I didn’t want a piece of equipment in the house that might go unused or, as my dad would say, become a very expensive clothes hanger. Plus, once owned, there would be zero excuses to not exercise. Not spinning would highlight laziness and lack of both willpower and commitment to health. So, rather than put that undue stress upon myself, I delayed placing the order.

As I began speaking with existing Peloton owners, it became clear I would indeed get lots of use from the bike. One of our clients from Birmingham, AL, told me he has used a Peloton consistently for several years and encouraged me to move forward with the purchase. Around the same time, I had my annual physical, where my doctor informed me that the health decisions I make in my 50s will set the stage for life in my 60s.

I ordered the Peloton on January 9, 2021. Unfortunately, my timing was off. A typical delivery time of several weeks was extended to many months thanks to COVID-19 supply-chain bottlenecks. My Peloton fitness regimen would have to wait until April 9th, when J.B. Hunt would finally arrive with my new exercise companion.

After a recent ride, I checked my workout history. Since getting the Peloton, I have logged over 200 workouts, and I am still going strong. The thought occurred that I may not need to worry about a 2022 New Year’s resolution. My new-year commitments are typically fitness-related, and today I have been following my exercise plan for months.

Aside from assessing personal health and fitness, January is also a time when investors often revisit their financial health and investment plans. With the holidays over and tax season on the horizon, the beginning of the year is a natural time to do this.

Formulating an investment plan is somewhat straightforward; sticking with the plan is often a challenge. We all are exposed to outside influences, including alarming headlines from the media, an ever-growing amount of promotional investment emails, events of the day, and concerns of future events that may or may not occur. The constant barrage of information makes investing a much more difficult task, as emotions around investment decisions can lead us astray.

Fear and Greed

Sticking to an investment plan can be just as difficult in bull markets as it is in bear markets. In bear markets, fear is the dominant emotion that can derail a well-formulated investment plan. In bull markets, greed can wreak just as much havoc. Hearing about friends, neighbors, or a half-wit relative making two or three times their money in a short period of time would make anyone envious. You start to wonder what is so great about your investment plan when you aren’t making the kinds of returns “everyone” else seems to be making.

And it isn’t just individual investors who are prone to abandon a well-formulated investment plan in bull markets. Institutional investors make the same mistake. Some do it purely out of emotion. Other managers get pressured into purchasing shares of companies that have no business being held in a prudently managed portfolio simply because they are evaluated on short-term relative performance.

Tesla

Tesla is a stock that is creating major relative-performance risk for portfolio managers today. Added to the S&P 500 last year, Tesla is now one of the most highly valued companies in the world. Tesla makes quality electric vehicles (EVs), and under the leadership of Elon Musk (a truly brilliant individual), the firm has impressively scaled up manufacturing after being on the verge of bankruptcy only a couple of years ago. But Musk’s genius and Tesla’s newfound manufacturing prowess don’t make Tesla a prudent investment.

In fact, Tesla is far from it, in our view. We believe Tesla is a largely speculative bet on a possible future that implies that something close to a winner-take-all situation will arise in the fiercely competitive auto industry. The company is worth more than the combined value of almost all legacy auto manufacturers. This is true, despite the fact that Tesla is only projected to sell approximately 890,000 vehicles in 2021. In a normal year, the global market is a 90-million unit industry. That’s about a 1% market share for Tesla, the world’s most valuable auto producer. We believe that the assumptions investors are making to justify Tesla’s nearly $1-trillion current market value are simply implausible.

Tesla Part of Broader Mania in Electric Vehicle Stocks

Tesla isn’t the only EV stock being valued using implausible assumptions, though. In fact, Tesla shares look reasonably priced if you compare them to Rivian and Lucid Motors. Both are newly public EV companies. Rivian is valued at $100 billion and Lucid at $65 billion. Neither company has generated any meaningful revenue to date. In our view, a bona fide mania is occurring in the electric vehicle space.

EV-mania is just one sign of the speculation and FOMO (fear of missing out) prevalent in today’s markets. Crypto appears to have gone bananas with joke coins like Dogecoin and Shiba Inu valued in the billions. There are software stocks that have performed incredibly well over recent years, trading at 15, 20, or even 30 times sales. Meme stocks such as Gamestop and AMC seem to trade without regard to fundamentals. Big-cap technology shares are priced at levels that rival the dot-com bubble. By example, Nvidia, the largest chip maker by market value (but not sales), is trading at 85X earnings. To put that into context, when you pay 85X earnings for a business, assuming no profit growth, it takes 85 years to earn back your investment.

The speculative element in markets is almost unavoidable. Speculation is even running rampant in the S&P 500 index. Recent commentary from Alhambra Investments highlighted some sobering statistics on the S&P 500:

The top 10 stocks in the S&P 500 make up 30.1% of the fund. Is this the diversification you expected when you bought an index with 500 stocks?

These top 10 stocks have an average P/E of 43.7. Yes, that includes Tesla at 137 times earnings (based on data from Morningstar) so if we take that out the average drops to… 33.3.

The top 20 stocks in the index make up 38.9% of the fund with an average P/E of 38.3.

The top 25 stocks make up 42.2% of the fund with a P/E of 34.6.

Two of the stocks in the top 10 are different share classes of Alphabet (Google). So you really have 30% of the fund is just 9 stocks. Furthermore, if you exclude JP Morgan and Berkshire Hathaway, you have 27.6% of the fund invested in 7 companies: Microsoft, Apple, Amazon, Tesla, Alphabet, Meta Platforms (Facebook), Nvidia (chip maker for crypto mining). Do you think those companies will be in the top 10 a decade from now? Only 4 of the top 10 from 2011 are still in there. Only one stock from the 2000 top 10 remains (Microsoft).

The current concentration of the fund is unprecedented. Its long-term average is about 18% in the top 10. It reached 26 during the dot com mania. Is it still prudent to use this fund as your main equity exposure?

A Balanced Approach

At Richard C. Young & Co., Ltd., we seek to avoid the speculative elements in the market by pursuing a balanced approach. A mix of bonds, dividend-paying stocks, and precious metals has most often helped limit risk in our clients’ portfolios while delivering an acceptable return. A well-diversified balanced portfolio will probably never earn the highest return in any single year, but it is also unlikely to deliver the worst return.

Focus on Investment-Grade Corporates

In bonds, we focus on investment-grade corporates. We currently favor an intermediate maturity and duration. Duration is a measure of the interest rate sensitivity of bonds. The longer the duration of a bond, the greater its interest rate sensitivity. With interest rates near record lows today, some investors are avoiding bonds altogether out of concern that rising interest rates will hurt the value of their bond portfolio. This is not a concern we share. Not all bonds are equal. Longer duration bonds would likely suffer large price declines if there were a significant increase in long-term interest rates. For the intermediate-term bonds we currently favor, the price fluctuations tend to be much more modest. In addition, we are also holding a higher than normal cash allocation, which helps lower the total duration of the “fixed income” assets in our clients’ portfolios.

A Bad Year in Bonds is Down 5%

In the almost 50-year history of the Bloomberg Intermediate Corporate Bond Index, there have only been four down years (assuming 2021 ends in negative territory). The worst year on record was 2008 when the index lost 4.82%. Importantly, that loss was not because the general level of interest rates rose (the bond bears’ concern today), but because of the risk of widespread defaults from the financial crisis.

Avoiding Speculation with Global Dividend Payers

For stocks, we favor a globally diversified portfolio of companies that pay dividends and intend to raise their dividends regularly. We favor established blue-chip-type holdings with durable businesses that have weathered a business cycle or two. Startups and companies with unproven track records are avoided.

When it comes to dividends, we seek to balance dividend yield and dividend growth. We don’t chase income in the highest-yielding stocks. More often than not, dividends of the highest-yielding companies are at the greatest risk of being cut. We want an above-average dividend yield today and the prospect of a higher dividend tomorrow.

The Opportunity in Energy

The energy sector is a dividend-rich sector and one of interest for us today. Energy shares are deeply out of favor with the institutional investing crowd. ESG investing has become a dominant strategy in the market. Apparently BlackRock, and many other institutional investors, see themselves as climate crusaders. Despite that they are supposed to be fiduciaries for their clients and not political activists, firms overseeing $130 trillion in assets have joined the Glasgow Financial Alliance for Net-Zero. Richard C. Young & Co., Ltd. is not a member. 

With institutional investors actively avoiding oil and gas companies for non-economic reasons and government policy seeking to incentivize alternatives, capital investment in the energy sector remains depressed despite elevated oil and gas prices. The chart below compares the Baker Hughes U.S. Oil Rig Count with the price of West Texas Intermediate crude oil. The rig count remains below pre-pandemic levels despite oil prices being meaningfully above pre-pandemic levels.

Without significant capital investment in the oil patch, production naturally declines as wells are depleted. Even if oil and gas firms ramped up capital investment tomorrow, it would take time for production to respond. As a result, the oil market is likely to remain tight well into next year. That bodes well for oil company stocks. 

It is also important to point out that hostile government policy toward fossil fuel companies does not mean conventional energy stocks are bad investments. An old-hand value investor, Bill Smead recently said this in Barron’s: “I was 10 years old when the U.S. government banned tobacco ads on television. Guess what was the best-performing stock on the New York Stock Exchange over the next 40 years? Philip Morris [PM].” 

Could Chevron or Phillips or another oil company become one of the top-performing stocks over the next 40 years? We wouldn’t rule it out.

CVS Making a Run

Patience is fundamental to achieving long-term investment success. The power of compound interest is not harnessed over weeks or months but over years and decades. Patience is also fundamental to investing in companies. Sometimes companies go through rough patches. As a shareholder, it can be frustrating to experience these periods, but a patient approach can be rewarded. From 2018 until the spring of 2021, CVS’s stock price made little improvement and even went through periods of loss. Of late, things seem to be improving. 

In general, we seek to maintain a buy-and-hold mentality, but for various reasons, we are never hesitant to sell a position. With CVS, its struggling share price was not reason enough for us to sell. During this period, the company maintained its dividend and repaid a significant portion of the money it borrowed to acquire Aetna. Debt reduction, while not as appealing as additional dividend payments, ultimately benefits shareholders. How? Paying down debt reduces lenders’ claims on a company’s assets. A smaller slice of the pie for lenders means a bigger slice of the pie for shareholders.

CVS is a business we continue to like. With a pharmacy benefits manager and an insurance company serving 39 million consumers, CVS is obviously more than a retail pharmacy. CVS sees itself as a leading health solutions company. CVS plans to move deeper into primary care and home health-care. It plans to close 900 existing pharmacies over the next three years and will have three types of retail storefronts with two focused on delivering health-care services. 

As part of this recently announced vision, CVS also said it would resume buybacks for the first time since 2017, and the board of directors has decided to increase its dividend by 10% next year. CVS shareholders are up handsomely YTD. 

Have a good month. As always, please call us at (888) 456-5444 if your financial situation has changed or if you have questions about your investment portfolio.

Warm regards,

Matthew A. Young
President and Chief Executive Officer

P.S. After three consecutive double-digit years of gains in the stock market, investors would be wise to lower their expectations in 2022. David Solomon, chairman of Goldman Sachs, recently said, “I’m not a believer that double-digit equity returns compounding in perpetuity is something as an investor you should expect. I’ve been involved with a number of investment committees and charitable foundations, college boards, etc., and certainly, my mindset is the returns we’ve received over the last three to five years are different than what we should expect as we go forward.” We continue to favor stocks that are big, blue-chip-type companies that are dominant in their industry and generate cash.

P.P.S. For decades, meaningful inflation hasn’t been an issue for companies to navigate, but that hasn’t prevented Lowe’s and Home Depot from doing so successfully this year. A combination of less frequent purchases by consumers and a broad assortment of inventory has allowed Home Depot and Lowe’s to tactically tweak their prices to cover higher costs. A recent WSJ article explained it like this: “If the cost of stocking paint goes up quickly for Lowe’s, it can react by making paint, paintbrushes, and trays all a little bit more expensive, for example. That way, shoppers faceless sticker shock on individual items.”

P.P.P.S. CNBC recently ranked Richard C. Young & Co., Ltd. number five on their list of top 100 advisory firms that best help clients navigate their financial lives.

* Rankings published by magazines, and others, generally base their selections exclusively on information prepared and/or submitted by the recognized advisor. Rankings are generally limited to participating advisors and should not be construed as a current or past endorsement of Richard C. Young & Co., Ltd. Barron’s is a trademark of Dow Jones & Company, Inc. All rights reserved. The information contained in this letter is for informational and educational purposes only. It is not intended, nor should it be considered investment advice or a recommendation of securities. Past performance is not a guarantee of future results. It is possible to lose money by investing. You should carefully consider your investment objectives and risk tolerance before investing. Please contact our office directly with any questions regarding items appearing in this letter.