Elections and Markets
Through the end of June, the stock and bond markets have been fairly calm despite this being a Presidential election year and the unpredictability that it brings. This election appears to have more uncertainty given the possibility that (as of this writing) the incumbent might step aside for another nominee to head the ticket. There is precedent for this when in 1968 President Johnson declined to run and his Vice President, Hubert Humphrey led the ticket. Intuitively, Presidential election years can add to uncertainty, which could lead to market volatility. However, viewing this through a historical lens provides a different perspective on the notion of election-year market instability.
The Standard & Poor’s 500 Index (S&P 500) has averaged a 7% gain in U.S. presidential election years since Dwight Eisenhower won the presidency in 1952. There have been 18 presidential elections since then. The return is somewhat below the average yearly return for the last 50 years of 11.3%. This particular election year is a re-election year in which an incumbent is seeking a second term. The average return since 1952 for that scenario is 12.2%, closer to the long-term average. In 1968, a volatile political year, the S&P returned 8.1%. Of course, it’s important to remember that past performance does not guarantee future return.
As outlined in an earlier Delta quarterly perspective, trying to time the market based on anticipating market directions historically hasn’t yielded a better outcome than remaining in the market. Jeff Sommer in his weekly New York Times market commentary recently observed: “Starting with the Eisenhower administration in 1953, if you had put $1,000 into the S&P 500 and kept it there only during Republican administrations, through March 20, 2024, it would have been worth $27,400. If you had invested only during Democratic administrations, your stake would have been $61,800. But if you had just held all the way through, you would have had $1.69 million.”
Typically, incumbents seeking re-election will propose and attempt to implement fiscal pro-growth and stimulus measures to support employment and the economy. Although President Biden faces a Republican-controlled House and has limited opportunities to “prime the pump,” most of the spending from the 2022 Inflation Reduction Act is slated for fiscal years 2024-2026, which could create a tailwind for the economy and the stock market through this election cycle.
As the election season unfolds, it is reasonable for investors to anticipate how the election might affect the economy. Many of the 2017 tax cuts are set to expire at the end of 2025. Tariffs have been discussed and used by each party, which could impact price levels and global trade. Inflation during the last couple of years has been at the highest rate since the 1980s.
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Except for the COVID-19 pandemic’s early days, the market and the economy have performed well under both Trump and Biden administrations. The American political system disburses and balances power. In many elections, at least one house of Congress is controlled by the party in opposition, thus Congress has tended to serve as a brake on major changes by whomever occupies the White House.
In mid-June, the Federal Reserve Board held interest rates steady. The benchmark was raised last year to a range between 5.25% and 5.5%. The Fed is balancing the risk of cutting too soon and allowing inflation to persist against the risk of maintaining rates too high and triggering a recession. The Fed’s approach has met with some success. Two years ago, the six-month annual pace of core inflation was 6%. It has dropped to 3% without a recession.
Fortunately, the economy has been resilient and has afforded the Fed more room to maneuver in raising rates. At the time the Fed began increasing rates, private sector balance sheets were robust, and many businesses and households locked in ultralow borrowing costs allowing them to weather rate hikes. The economy is a complex, inter-dependent mechanism prone to excesses and cycles. It also benefits from self-correcting mechanisms from free markets that are supplemented by monetary and fiscal policy. Election year uncertainty is just one of many factors that can influence the markets. The overall economy, interest rates and consumer sentiments are weightier determinants.
June 30, 2024
Company Comments
Comments follow regarding common stocks of interest to clients with stock portfolios managed by Delta Asset Management. This commentary is not a recommendation to purchase or sell but a summary of Delta’s review during the quarter.
The Procter & Gamble Company { PG }
Since its founding in 1837 by William Procter and James Gamble, P&G has grown to be the world’s largest and one of the most profitable consumer products companies with over $82 billion in sales and over $18 billion in operating profit. Procter & Gamble sells its products in more than 180 countries and territories. The company’s diversified portfolio of branded products includes major brands, such as Crest, Gillette, Olay, Oral-B, Pampers and Tide. P&G has built or acquired a portfolio of 21 brands that each generate between $1 billion and $10 billion in revenue each year.
P&G’s success has been built on a long-standing business model: discover meaningful insights on consumer needs and wants through deep consumer research and understanding; translate those insights into product innovation; and create compelling marketing and advertising to convince consumers of the superior performance and value of P&G products. P&G’s brands often hold top market share positions in their respective categories. Its sheer size confers economies of scale benefits in manufacturing and distribution, giving it a strong bargaining position versus its retailers.
P&G has completed a major five-year transformation that led to a 70% reduction in brands and $10 billion in cost savings. The company was focused on reducing overhead costs and employing better cost efficiency in its manufacturing and distribution. As a result, P&G’s more focused portfolio now consists of 10 product categories and 65 brands that still maintain broad consumer appeal and reach. The company has centered its portfolio on its strongest brands with large market positions and the best opportunities for both revenue and profit growth.
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P&G’s new CEO, Jon Moeller, is focusing on growth across the company’s remaining broad product portfolio. In 2023, the company experienced its second consecutive year of 7% organic sales growth and fifth consecutive year of 5% or better organic growth. E-commerce sales increased 7% in 2023, now representing 17% of total company sales.
Management is also focused on using its cost savings and improved cash flow to increase innovation and marketing spend on core brands to continue to accelerate organic growth. This strategy and the resulting investments have been successful over the past few years as evidenced by above market growth, market share gains and higher profitability. Innovation and a disciplined emerging market expansion strategy will continue to be a driving force behind P&G’s long-term growth outlook. The company invested over $2 billion on research and development costs in 2023.
P&G has significant market share and usually controls one of the top spots in most categories and segments in which it competes; however, the company does face strong competition from branded and store-brand offerings. These competitors have at times been especially aggressive in discounting and promotional activity. P&G realizes the need to defend its market share and has been more hard-hitting in its pricing adjustments and promotional activity in its major categories and geographic markets. Another potential risk is its exposure to rising commodity costs. If combined with lower shelf prices, rising commodity costs can cut significantly into margins.
In April 2024, P&G raised its dividend by 7% to $4.03 annually. The company has paid a dividend for 133 consecutive years and has increased its dividend for 67 consecutive years. Only three U.S. publicly traded companies have raised their dividend more consecutive years.
Given P&G’s concentration in mature markets and increasing exposure to faster-growing developing markets, we believe the company can grow revenue by over 4% during the next decade. Given this rate of growth and continued productivity and efficiency improvements, we have assumed the company can achieve operating margins of approximately 23% over our modeling period. Based on these assumptions, our stock valuation model indicates P&G’s current stock price offers a long-term average annual rate of return of approximately 5.9%.
Baxter International Inc. { BAX }
Baxter International provides a broad portfolio of essential renal and hospital products, including acute and chronic dialysis, IV solutions and administrative sets, infusion systems and devices, nutrition therapies, biosurgery products and inhaled anesthetics as well as pharmacy compounding, drug formulations, and digitally equipped medical beds, software and service technologies.
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Baxter is spinning off its renal care division with the acute therapies division into a separate, publicly traded company to better help drive growth by having a more targeted focus on investment and capital allocation. |
The company’s global footprint and the critical nature of its products and services play a key role in expanding access to healthcare in emerging markets and developed countries. Baxter is among the global market share leaders in all its businesses with manufacturing in 20 countries and products and systems sold in 100 countries. The company’s manufacturing scale, worldwide distribution and product breadth in injectable and inhaled therapies make the firm an important supplier to caregivers.
Research and Development expense currently runs at approximately 4% of revenue, which management believes should ensure a pipeline of new products into the future. Baxter recently received Food and Drug Administration clearance for its Novum IQ LVP pump and software system. This is an integrated platform in which dosage can be administered in high volume infusions at faster rates. The fluids can be administered remotely by healthcare providers.
Baxter’s medical delivery and dialysis businesses are comprised of a diversified mix of both basic and innovative products. The company maintains large global market shares in mature but stable products, such as IV administered therapies, infusion systems and nutritional solutions. Baxter offers the broadest selection of pre-mixed drugs in the industry and continues to expand revenue from innovative drugs, such as inhaled anesthesia. The consumable and medically necessary nature of Baxter’s products provides relatively consistent revenue and operating cash flow.
Baxter has initiated strategic changes to its organization. First, the company has created a strategy centered around portfolio optimization, operational excellence and strategic capital allocation. The company’s plan to continue to drive sales growth and profit margin improvement includes a focus on several high margin businesses (Acute Renal Therapy, Biosurgery, Inhaled Anesthesia and Nutrition). The company also will continue to reduce its manufacturing footprint and capture additional supply chain efficiencies. Baxter is spinning out its renal care and acute therapies divisions into a separate, publicly traded company to better help drive growth by having a more targeted focus on investment and capital allocation. The company also sold its BioPharma Solutions business for just under $4 billion in September 2023. After-tax proceeds were used to repay debt obligations.
In 2021, Baxter purchased Hillrom, a company that makes digitally equipped hospital beds and operating room equipment. There is potential revenue synergy in that Baxter’s products already sell into hospital and clinical settings. Baxter’s salesforce should be at an advantage for Hillrom’s products to expand further into international markets, which represent 59% of Baxter’s sales but only 32% of Hillrom’s. To acquire Hillrom, Baxter increased the leverage on its balance sheet that will need to be reduced.
Baxter’s main challenges include increasing competition in its more commoditized offerings and continuing efforts on cost containment in the healthcare industry in general that may exert pricing pressure on medical products. In addition to government regulation, managed care organizations’ purchasing power has strengthened due to their consolidation into fewer, larger organizations with a growing number of enrolled patients. Quality control is also a risk factor. Product recalls can harm relationship trust. In addition, Baxter faces regulatory risk. Many of its products are subject to approval by the FDA and regulatory agencies in other countries.
We believe Baxter can generate long-term revenue growth in the 3% range with cash flow margins approaching 19%. Based on these assumptions, our valuation model indicates Baxter’s current stock price offers a long-term average annualized rate of return of approximately 11%.
United Parcel Service, Inc. { UPS }
UPS is the world’s largest package delivery company in an industry where network size matters, both in terms of customers and spreading costs over a larger volume of packages. The company was founded in 1907 as a private messenger and delivery service in Seattle, WA. For calendar year 2023, UPS delivered on average about 22.3 million packages per day, generating $90.9 billion in revenue.
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The parcel industry enjoys favorable competitive dynamics. A start-up would find it difficult to replicate a competitive network quickly. The barriers to entry are high as carriers own and/or lease large fleets of airplanes and trucks, trailers, terminals, sorting equipment, drop boxes and IT systems. Despite its asset intensity and extensive unionization, UPS produces returns on invested capital ahead of its cost of capital and margins above its competitors. This success is due to the firm’s investment in technology and operational efficiency.
Although there is intense rivalry between FedEx Corporation and UPS, pricing tends to be rational and price wars rare. UPS normally produces higher profit margins than its peers, due to its use of integrated assets to transport U.S. express and ground shipments through the same pickup and delivery network. UPS clients have the convenience of using the same driver to handle both express and ground packages, and it benefits from greater operating efficiency than its competitors. The United States Post Office is both a competitor and partner, sometimes delivering UPS packages the last leg of a shipment.
Over the past decade, UPS has significantly expanded the scope of its capabilities to include more than package delivery. Its logistics and distribution capabilities give companies the power to expand their businesses to new markets around the world. UPS provides shipping, logistics and return services for internet retailers whose sales are growing three to four times faster than those of brick-and-mortar stores.
The parcel industry is a major beneficiary of internet sales trends. Throughout the world, online buying has grown exponentially. We expect e-commerce growth to continue at a high rate over the long-term. The gains from internet sales have recently been modestly tempered by product digitization and miniaturization, which reduces average package volume and weight. Despite these trends, a broader selection of products is being purchased online as younger generations are more comfortable with online transactions.
The shift toward e-commerce has led to a structural increase in the capital required to meet ever-evolving customer demand. UPS invests $1.0 billion a year in information technology investments. Such a level of commitment is a material part of its 2023 $5.1 billion plus capital expenditure. This investment has paid off in efficiency and reduced costs. For ground delivery, UPS indicates its ORION route optimization has reduced costs by $400 million.
Amazon has been in-sourcing more of its own last mile delivery needs at a rapid pace. UPS revenue from Amazon fell to $10.7 billion in 2023, down 5.3% from the previous year. That said, Amazon has limited national linehaul capability. We believe Amazon will continue to partner with UPS to meet its growing demand for capacity.
In June 2023, UPS struck a new five-year deal with the Teamsters covering 250,000 workers. Although the agreement included rapid wage gains, UPS retained the ability to offset labor with automation. In the future, robotics may increase productivity and lower wage costs.
UPS has demonstrated high capital efficiency and strong cash flow generation throughout its history. The industry has benefited from three intertwined forces: the emergence of China, the broad trend toward just-in-time inventory and the rise of internet commerce. The company should continue to benefit from volume growth from businesses shipping to consumer, an oligopolistic industry structure and growing global trade and supply chains. Based on these assumptions, our stock valuation model indicates a long-term average annual rate of return of approximately 10.4%.
June 30, 2024
Specific securities were included for illustrative purposes based upon a summary of our review during the most recent quarter. Individual portfolios will vary in their holdings over time in relation to others. Information on other individual holdings is available upon request. The information contained herein has been obtained from sources believed to be reliable but cannot be guaranteed for accuracy. The opinions expressed are subject to change from time to time and do not constitute a recommendation to purchase or sell any security nor to engage in any particular investment strategy. Any projections are hypothetical in nature, do not reflect actual investment results and are not a guarantee of future results and are based upon certain assumptions subject to change as well as market conditions. Actual results may also vary to a material degree due to external factors beyond the scope and control of the projections and assumptions.