Welcome to the April newsletter! Today we’re going to review the current economy and stock market trends, as well as the Blockchain and Bitcoin to see how it all influences your portfolio. Let’s take a look, shall we?
Summary
The stock market remains in a bull market but is temporarily in a correction. The bond market is in a bear market with interest rates rising and existing bond prices falling. No recession is in sight and all portfolios remain fully invested. Below we have an update on Wells Fargo and we answer the question, what is the Blockchain?
The Economy
The non-farm payroll jumped dramatically to 313,000 in February. Also, the January payroll number was increased from 200,000 to 239,000, and December’s number increased from 160,000 to 195,000. For five months in a row, the headline unemployment rate has stayed steady at 4.1% as more and more people enter the workforce. The broadest measure of unemployment (U-6) remained steady at 8.2%.
Wage inflation took a step back as the February number was up only 2.6% year over year.
The Labor Department announced initial jobless claims fell to a seasonally adjusted 226,000 in the week ended March 10. Weekly joblessness claims have held below 300,000 for about three years. The overall labor market remains broadly healthy.
Stock Market
Commentary
The stock market continues to be in a correction. The market established an all time closing high of 2872.87 on January 26, 2018 as measured by the S&P 500 Index. Then the correction began with a steep waterfall decline to 2581.00 on February 8 on a closing basis. This put the market down 10.16%.
The next day on February 9, the market established an intraday low of 2532.69. This intraday low was down 11.84% from the January 26 closing high.
A subsequent short-term rally stalled and on March 23, the closing low was re-tested at 2588.26. This should have been enough to announce an all out buy, but market internals were insufficient to make that call.
Now, the intraday low of 2532.69 on February 9 was re-tested with an intraday low on April 2 of 2553.80. We continue to monitor if an all out buy signal will be generated.
Please remember, corrections do not end a bull market.
For those who are skittish that this correction could turn into a raging bear market, let’s review the five primary causes of a bear market:
Tight Money – We regard current monetary policy as “accommodative” while recognizing the combined FOMC policy measures of raising short-term rates along with Quantitative Tightening represent a gradual withdrawal from the previous high degree of monetary stimulus. Tight money does not exist in today’s economy; therefore, it is not a cause to fear a near-term bear market.
Rising Interest Rates – In our view, the 10-year Treasury yield is likely to gradually increase until it mirrors the nominal rate of growth of gross domestic product (GDP). For example, if nominal GDP growth is 4.5% (2.5% real growth plus 2.0% inflation), then a 10-year Treasury yield of 4.5% would represent a normal level. Today the 10-year treasury yields 2.73%. Therefore, current interest rates do not indicate a near-term bear market.
High Inflation – The PCE price index has risen 1.8% over the past year, while the core PCE price index shows an increase of only 1.6%. We do not have high inflation and there is no sign of a bear market.
Rapid Growth – The Federal Reserve median estimate for 2018 looks for real GDP growth of 2.7%. This is only a moderate level of economic growth and will not push us into a bear market.
Overvaluation – Based on our price/earnings ratio estimate of 17.5 to 18 times earnings, the S&P 500 Index has the potential to trade in the 2900s, as 2018 operating earnings should reach $152 this year. Reaching the 2900s allows for an overvaluation which frequently occurs in an extended bull market. With a current S&P 500 Index at 2582, we are not overvalued and there is no sign our current market valuation will cause a bear market.
Whether or not this market correction generates an all out buy signal is yet to be seen. But we fully expect this bull market to continue with significant upside returns from today’s market level.
Recommended Action for Your Stock Portfolio
All portfolios remain fully invested. There should be no selling during a correction. A buy signal might develop. If this happens, Lorenz Financial will make the appropriate announcement.
Economic Indicators
The following ranges are provided as to where the Federal Reserve members expect the following economic indexes to finish 2018:
Real Gross Domestic Product – 2.6% to 3.0%
Unemployment – 3.6% to 3.8%
PCE Inflation – 1.8% to 2.0%
Core PCE – 1.8% to 2.0%
Federal Funds Rate – 2.1 to 2.4%
Wells Fargo Update
Last month, we repeated the warning from the former Federal Reserve Chair, Janet Yellen, when she said we could not tolerate the pervasive and persistent misconduct at Wells Fargo’s retail banking unit. Now the FBI and the Securities and Exchange Commission has launched an investigation into Wells Fargo’s wealth management business. Lorenz Financial continues our recommendation that everyone with a bank account, credit card, home equity line of credit, or brokerage account with Wells Fargo, immediately close all accounts.
What Is The Blockchain?
The Blockchain is the world’s leading software platform for the transaction of digital assets. Blockchain transactions do not pass through an intermediary such as a bank, government, or credit card company.
In its broadest form, the Blockchain is a digitized, decentralized ledger of transactions. Right now the public’s eye sees the Blockchain as the means of recording crypto-currency transactions. But, Bitcoin and the other crypto-currencies have obscured with hype the bona fide technology of the Blockchain. The Blockchain is so much bigger than and more important than Bitcoin.
Blockchain has the power to transform industries for two reasons. First, it’s genuinely well suited to record transactions that require 100% trust and a permanent record. For example, Blockchain fills this need for real estate transactions.
Second, the Blockchain can record the history of a product or commodity throughout its life. For example, a diamond for sale in Chicago can have its complete history recorded from the miner, to cutter, to wholesaler, and to the retailer. How can Blockchain tell the difference between one diamond and another? It can tell the difference by having 40 different characteristics of every diamond recorded. So far there are 2.2 million diamonds registered on the Blockchain with 100,000 being added every month.
Companies already using the Blockchain to track the logistics of their products from suppliers to consumers include the shipping company Maersk, Kroger, Nestles, Tyson Foods, Unilever, and Walmart. The list is continuously growing
As per some news reports, some people have had their bitcoins stolen. This is not a sign of a Blockchain failure. It was a failure thought of the “bitcoin exchange” to keep their client’s data safe.
Bond Market
Commentary
The bear market in bonds continues. Investors should definitely not hold any long-term bonds or long-term bond funds. Long-term is defined as “duration” greater than seven years.
The Fed’s stance on monetary policy remains accommodative. In the post Federal Reserve March meeting statement, the Federal Open Market Committee (FOMC) members noted, “the labor market has continued to strengthen and the economic activity has been rising at a moderate rate.” This is “Fed speak” for everything (economic growth, inflation, interest rates, and unemployment) looks good.
Federal Reserve
The FOMC held a two-day meeting on March 20-21. FOMC members voted unanimously to raise the target range for the federal funds rate by 25 basis points (0.25%) to a range of 1.5% to 1.75%. The next meeting for the FOMC is May 1-2.
In April, the Fed will increase the amount of quantitative tightening from $20 billion per month to $30 billion per month. This is an effort to reduce the Fed’s balance sheet of over $4.4 trillion of US Treasuries and mortgage-backed securities. The intent is to gradually push long-term interest rates higher as fast as the short-term federal funds rate is rising.
The Fed will likely raise short-term interest rates two or three times more in 2018 and another three times in 2019.
US Treasuries
The recent increase in the federal government’s deficit spending and the Federal Reserve’s selling of US Treasuries to reduce their balance sheet is forcing the Treasury to unleash a tsunami of new US Treasury bills, notes, and bonds. As the supply goes up, bond prices will surely go down as these bonds MUST BE SOLD TO SOMEONE AT ANY PRICE. When bond prices decrease, their yield increases. We are headed towards higher long-term bond yields and lower long-term bond prices. Therefore this is not the time to own long-term bonds or long-term bond funds.
Inflation
The Bureau of Economic Analysis announced the latest inflation numbers as per the Personal Consumption Expenditure (PCE). Headline PCE was up 1.80% year over year in February. Core PCE, which excludes food and energy, was up 1.6% year over year.
As measured by the difference between Treasury bond yields and TIPS yield, inflation expectations can be calculated. See the results below.
Treasury Bond Inflation
Maturities Expectations
5 Year 1.92%
10 Year 2.05%
30 Year 2.07%
Recommended Action for Your Bond Portfolio
Our bond market investments remain unchanged. We are investing only in short-term investment-grade bond funds, intermediate-term investment-grade bond funds and short-term high-yield bond funds. We are not recommending any long-term bonds or long-term bond funds. Muni bond funds are not recommended at this time due to the risk of some US cities going bankrupt. Treasury bond funds are not recommended at this time due to their low yield.