I joined Advisors Capital Management in March of 2015, and at numerous investor events between then and now, I have been repeatedly asked whether the market has reached its peak. The S&P 500 is up 35% since that spring of 2015 when I gave my first presentation to a roomful of advisors and clients on the state of the market and the economy. A meeting last week in L.A. saw many of the same questions and concerns raised once again by advisors: How much farther can the market climb? How much longer can the U.S. economy grow? How can we manage investments in the face of political risks, rising interest rates, and the eventual arrival of recession? The fact that Apple’s stock was set to cross the $1 trillion mark seemed almost another sign that stocks have risen so much that these good times surely could not last much longer. But it is in looking more closely at Apple’s story that we can indeed see the reasons to have greater faith in the market’s ability to move even higher.
We all know the basic history of Apple – from the revolution in personal computing through the iMac and Macbook, to music in your pocket with the iPod and iTunes, and then on to the iPhone, iPad, Watch, AirPods, AppleTV and more. Once Steve Jobs returned to lead Apple in 1997, innovation resumed in earnest. Once the dust of the early-2000’s recession settled, investors could see renewed revenue growth through the iPod, and Apple’s stock doubled, tripled, quadrupled and more. Between the beginning of 2004 and the end of 2007, Apple’s stock had risen nearly 1,600%. Some investors must surely have thought at the time that AAPL had peaked.
Those increases in AAPLs’ price in the mid-2000s were based on forecasts of Apple revenue and profit growth driven largely by those early iPod models. No one at that time could foresee the iPhone, iPad, or any other future products. When those came into the picture, profit forecasts moved even higher and, with them, so did the value of the company. The value of the Apple Corporation has risen over 13,400% since 2004. It turned out AAPL had not peaked at the end of 2007. Do reasonable investors think it has now? Or that this is a bubble? No—they see this as a company producing more stuff over time and delivering more profits. When companies create new products, they give investors cause to increase profit forecasts, and so to raise the expected value of the company—and its stock. Stock ownership represents a bit of ownership in a company—a very small bit—and that ownership entitles the holder to any dividends the company pays forever and to enjoy (or suffer) any increase (decrease) in stock value upon sale. As an investor, you essentially own a bit of the entire future stream of profits the company will ever produce. Nice. Unless that company you owned was Kodak.
The S&P 500 since 2004 has risen 253%. The market—in this case the S&P 500—is simply the weighted values of the companies in that index. And just as for Apple, the values of the other companies in the S&P 500 increase if investors expect those companies to deliver higher future profits by way of creating more products and services and by keeping costs under control. Today, the market trades at 16.1 times projected 2019 profits—investors are paying $16.10 for $1 of next year’s average earnings from all 500 or so companies in the S&P 500, but they are paying that price since it entitles them to the entire future stream of those companies’ profits. That multiple is roughly in line with its 50-year historical average (16.0 times) and is less than periods in which inflation is as low as it is now (when the market traded at 19.5 times). Investors are expecting those profits to continue to grow. And if they do, the S&P 500 would continue to climb.
But those expectations can change, and when they do, valuations, for Apple and all the other S&P companies, can rise or fall. The macro data is encouraging, as Friday’s jobs report affirmed. It suggests a healthy global environment for continued profit growth. Trade tensions are, however, tempering those expectations, and have led to recent volatility in stock prices. A recession is certainly in our future, but as yet, the data doesn’t point to its imminent arrival. Earnings growth, this year expected to reach 21%, will slow, but we cannot now know what new goods and services companies will invent in the future that would lead earnings growth to re-accelerate. As investors, we must continue to research end markets and company prospects, and endeavor to own bits of companies that have the greatest potential to deliver better profits and at a reasonable price. Provided companies, at some point, produce more stuff and create more profits than investors expect, the S&P 500 will continue to rise—just like Apple. It certainly will not happen smoothly—since all sorts of economic and political conditions can alter expectations and profits—but barring a fundamental, long-lasting, and global dislocation of the economic order, the average company in the S&P ought to become more valuable over time.