McDonald’s Reports Great Results
With the weakness from the Starbucks earnings report, investors were uncertain whether Starbucks did poorly because of execution issues or because of macroeconomic issues. The company blamed changes in the consumers’ tastes for the miss. The holiday drinks didn’t sell well. This led me to believe the environment is fine; it was a company specific issue. That’s why the stock has done nothing for 2.5 years.
On the other hand, McDonald’s stock has been rallying ever since its turnaround 3 years ago. The stock is up 92.18% since January 23rd, 2015. It’s not a coincidence that McDonald’s is doing well while other quick serve and fast casual restaurants are underperforming. McDonald’s has been re-taking the share it had lost. In the past year, the company has won back over 500 million customer visits that it lost since 2012. In the quarter it reported on Tuesday, the global same store sales were up 5.5% which was 0.6% faster than expected; it was the fastest growth rate in 6 years. EPS was $1.71 which beat estimates by 12 cents. U.S. same store sales growth beat expectations by 0.2% coming in at 4.5%. The company took a one time tax charge like most of the financials did. It was an 84 cent per share hit which likely won’t be included in the FactSet numbers. The stock sold off 3.24% on the heels of these spectacular results.
The sell off in McDonald’s stock occurred because the great results were already baked in the stock. It also wasn’t helped by the weakness in the overall market on Tuesday. The sell off is a microcosm for what could occur this year. With the massive 35.55% rally in the S&P 500 since November 4th, 2016, the tax cut and cyclical optimism are mostly priced in. Earnings are expected to grow 14% and GDP growth is expected to be near the fastest of this expansion. There needs to be spectacular economic momentum for expectations to be beat. Stocks could sell off 10% even if everything goes according to the forecasts.
Long Term Stock Returns Still Look Problematic
Even though stocks have sold off in the past two days, the 10 year CAPE is still at 34.24. The chart below compares the past 7 years of annualized stock performance using CAPE with the next 7 years of annualized returns. As I’ve mentioned a few times, a low or average CAPE doesn’t mean much. In general, you should own stocks because they go up about 70% of the time. You should expect better returns when the CAPE is low; when the CAPE is average, returns vary widely. Generally, investors looking at the CAPE are long term value investors, so the concept of getting very aggressive through leverage and high beta when the CAPE is low is foreign to them. Essentially, the goal is to simply be long stocks most of the time.
The information gets very clear when the CAPE is between the low 30s and the mid 40s. Backward returns are great when the CAPE is high and future returns are terrible when it’s high. The biggest problem with CAPE is there aren’t many data points when the CAPE is this high. Even with about 130 years of data, the only instances where the CAPE was this high were in the late 1990s and 2000. You’re basing your view point on the performance after one spectacular run, the fact that the trend shows returns get poorer as valuations rise, and that international markets support the notion that a high CAPE equals low long term returns. There’s never going to be a guarantee that stocks will underperform, but it seems like a reasonable bet with a few caveats.
The chart below shows the potential and past returns of a few investments. The 15.8% compound annual growth rate in the past 5 years and the 4% expected CAGR in the next 5 years is similar to what CAPE projects. I’m assuming the years listed in the chart are wrong because the past 5 years is 2013-2017 and the next 5 years is 2018-2022. It’s interesting to see the returns on cash come much closer to the other investments. In the past 5 years, stocks did 15.5% better than cash per year. It was devastating to own cash which is why surveys show cash positions are near their record low. In the next 5 years, stocks are only expected to outperform cash by 1.9%. Cash could have a better Sharpe Ratio because there will likely be a bear market and a recession in the next 5 years.
Real estate, private equity, and hedge funds are all expected to perform badly which would be devastating for public pension funds. The only saving grace is that there will likely be higher bond yields which they can hold until maturity. I think the next 5 years will be devastating for pension funds. The issue is they have already failed to meet their goals in a rising stock market; imagine how bad performance will be in a falling market.
There’s an old adage on Wall Street which says “it’s a stock picker’s market.” This term is related to the correlations among stock prices, but money managers like to repeat it because it supports their industry. You won’t hear a money manager tell you to buy index funds because stocks will be highly correlated. The chart below shows the breakdown of various forward PE buckets. As you can see, there are much fewer cheap stocks than in March 2000 which was the peak of the biggest bull market in history. Therefore, if you’re a stock picker, it is going to be tough to find stocks that are ‘diamonds in the rough’; it’s tough to find stocks that are so cheap, that they will have good returns in the next 5 years even if the stock market goes down. There were a few more stocks with a forward PE of above 41 in 2000 because the bubble was very concentrated in a few tech names.
Recent Comments