Welcome to the August newsletter! Today, we’ll update you on the Federal Reserve and Treasury, the latest on raising the minimum wage, recommended actions for your stock and bond portfolios, and more. Let’s get started!
Summary
During the month of July, the S&P 500 Index achieved new all-time closing highs on July 3, 11, 12, 15, 24, and 26. Key economic indicators show low inflation, moderate economic growth, low interest rates, and very low unemployment. No recession is in sight and all portfolios remain fully invested.
Employees should continue to make their weekly or monthly contributions to their employer’s retirement plan or IRAs. The economy continues to grow steadily without run-away inflation. Additional money can be added to the stock market at any time on a dollar-cost-average basis.
The Economy
Employment
U.S. nonfarm payrolls rose in June by 224,000. This was higher than expected. The May payroll number of 75,000 was revised down to 72,000 and the April number of 224,000 was revised down to 216,000. The three-month payroll average increased from 151,000 last month to the current figure of 170,000.
Unemployment rose slightly from 3.6% to 3.7% as more Americans went looking for work. Total unemployed persons rose slightly from 5.9M to 6.0M. In June, the increase in “average annual hourly earnings” remained at 3.1%.
Gross Domestic Product
The U.S. economy grew at an annual rate of 2.1% in the second quarter. This is the Bureau’s first estimate of the second quarter. The increase reflects positive contributions from personal consumption expenditures and federal, state, and local government spending.
Inflation
Annual inflation was unchanged in June at 1.4%, as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, rose slightly from 1.5% in May to 1.6% in June. All numbers are changes from the same month one year ago.
Long-term inflation expectations can be determined by calculating the differences between Treasury bond yields & TIPS real yields of the same maturities. Results are:
| Bond Maturities | Annual Inflation Expectations |
| 5 Year | 1.56% |
| 10 Year | 1.76% |
| 30 Year | 1.81% |
Stock Market
Commentary
The S&P 500 Index closed on July 26, 2019 at 3025 – a new record closing high. The stock market has had quite a good run since the December 31, 2018 close at 2506. As of July 31, the S&P 500 Index was up 18.9%.
Since the bear market low of 676 on March 9, 2009, the S&P 500 is up over 340%. There will be a day when this bull market ends. If the next bear market is to be caused by normal fluctuations in business and financial markets, we do not yet have visibility of the beginning of that bear market. In the future, if we see it coming, we will make the appropriate announcement to our subscribers.
Will the following two leading indicators predict the next bear market?
1. The US Treasury Yield Curve as of July 31 is below.
There is a noticeable dip in the yield curve at 1 yr, 2 yr, 3 yr, 5 yr, 7 yr, and 10 yr. Those yields are below the yields at 1 mo, 2 mo, 3 mo, and 6 mo. Fortunately, there is a nice upward trend at 20 yr and 30 yr.
2. The Conference Board said the Leading Economic Index (LEI) declined in June, the first decline since December 2018.
The LEI spokesperson said, “As the US economy enters its eleventh year of expansion, the longest in US history, the LEI suggests growth is likely to remain slow in the second half of the year.”
Conclusion: Neither the US Treasury yield curve—nor the LEI—suggests the beginning of a near-term (9 to 12 months) recession.
Stock Market Valuation
We estimate 2019 S&P 500 Index operating earnings will be $167. Our preliminary 2020 estimate is $175. Based on our price/earnings ratio range estimate of 17 to 18 times operating earnings, we are increasing our S&P 500 Index target range to be in the 3100’s. (175 x 18 = 3150)
This stock market valuation takes into consideration our outlook for low inflation and the highly accommodative monetary policy now in place at the Federal Reserve.
Recommended Action for Your Stock Portfolio
We regard the risk of a recession as low at this time. Our two key pre-recession indicators continue to suggest the economy will continue on a slower but positive growth tract in 2019. Therefore, we recommend investors’ stock market allocation should be fully invested in a low cost, highly diversified and tax-efficient portfolio.
Additional money should be added to the stock market on a dollar-cost-average basis.
Should the federal minimum wage be increased to $15/hr?
Fortunately, the Congressional Budget Office (CBO) is mostly non-partisan. On July 8, 2019, the CBO published a paper on the likely results of increasing the federal minimum wage to $15/hr. On the good side, the CBO predicts 1.3M Americans will be pulled out of poverty. Certainly, that is a good thing.
But many low paying jobs will be lost. The CBO predicts with a $15/hr minimum wage, between 1.3M and 3.7M jobs will be lost. For example, fast food restaurants with perhaps 40 young (and older) people on the payroll will certainly reduce the number of employees. Some locations will be able to implement productivity increases to reduce the workload, but others will tell the remaining employees to “pick up the slack.”
Lorenz Financial is mostly concerned about future teenage employment – your children and grandchildren. When asked by an interviewer, “What work experience do you have?” a 16 year old looking for his or her first job will likely say, “I don’t yet have any work experience.” When the interviewer hears that response, how often will the candidate be offered a $15/hr job?
Mark acknowledges he wasn’t worth a lot during his first job at age 16, but then he was only making $1.50 an hour in 1969. Within a year he had learned the ropes and was likely worth more than his hourly wage even as it had increased to $1.65/hr. This learning process, which combines low wages for young, inexperienced, first-time employees, has worked well for decades but is now threatened by the US House of Representatives. They passed their $15/hr minimum wage bill on July 18 and sent it to the Senate where it is unlikely to come up for a vote.
Nothing Financial, But Just A History Lesson From 1826
On July 4, 1826, Thomas Jefferson, our 3rd US President, died. Five hours later on the same day, John Adams, our 2nd US President died.
Jefferson was an “anti-Federalist” who was opposed to the centralizing policies of the new Federalist party. Jefferson served two terms as President. John Adams was George Washington’s Vice President, a Federalist and served only one term as President.
Lorenz Financial vs Vanguard Personal Advisor Services
Vanguard does a lot of things right including offering low-cost mutual funds and a variety of index funds. Recently, Vanguard started offering Personal Advisor Services where they will manage a client’s portfolio. If an investor has at least $50,000, Vanguard’s fee is 0.30% per year – quite low.
Lorenz Financial offers portfolio management services also. Our fee varies with the client’s assets under management but for $1.5M to $3.0M, our fee is 0.35% per year. Our portfolio management service includes four distinct advantages over Vanguard’s.
1. An account at Vanguard means a client will only be put into Vanguard funds – and likely only Vanguard index funds. At Lorenz Financial, we offer clients index and managed funds from over 200 fund families. For those clients who want qualified dividends in their taxable account, we also offer individual stocks.
2. A Vanguard client will never meet with a Vanguard advisor face-to-face. Communication with a Vanguard rep will only be by a recorded phone call or by monitored email. At Lorenz Financial, a client can meet face to face with Mark as much as they want with no additional charge.
3. We are confident Vanguard will ask a new client about the objectives of their money, the client’s risk tolerance and tax status – just as we do at Lorenz Financial. But the portfolio construction will be up to Vanguard after that. At Lorenz Financial, we develop an investment plan with our clients before any buying or selling begins.
For example, a subscriber to this newsletter a few years ago hired Vanguard to manage his money. During mid-2016, the 10-Year US Treasury was paying only 1.37%. Rates began rising up to 3.24% in Nov 2018. During a rise in interest rates, the last place an investor wants their money is in an intermediate-term or long-term bond fund due to “interest rate risk.” But that is exactly where Vanguard put some of his money. When he figured this out, he fired Vanguard as his money manager.
4. Vanguard’s 0.30% annual fee is non-negotiable. Our fee at Lorenz Financial is always negotiable.
Bond Market
Commentary
The pace of economic growth in the US has decelerated from 3.1% in the first quarter to 2.1% in the second quarter this year. We are seeing broad weakness in rail traffic. Through the first 30 weeks of 2019, total rail shipments have fallen 3.4% while truck traffic rose 1.5% in June, year over year.
Port traffic in Los Angeles was up 5.3% year to date while Long Beach port traffic was down 6.8% over the same time period.
Good news for workers: We have now had more job openings than unemployed workers over the past 15 months. In our view, trade policy and tariffs remain the biggest risk to economic expansion.
Federal Reserve
The Federal Open Market Committee (FOMC) met on July 30 and 31. They voted to lower the Federal Funds rate from the range of 2.25% to 2.5% to the range of 2.0% to 2.25%.
The vote was 8 to 2, with the Boston and Kansas City Fed Presidents dissenting. Those two Fed Presidents preferred to keep interest rates constant. This is important as the likelihood of a rate cut in September has diminished.
U.S. Treasuries
A budget deal has been reached with Congress to avoid federal spending cuts in fiscal years 2020 and 2021. The agreement also suspends the debt ceiling for two years through the end of July 2021. This deal removes some of the headwinds for economic expansion over the next two years.
Recommended Action for Your Bond Portfolio
Our bond market recommendations have not changed since last month. We are recommending bond investors only participate in the following types of bond mutual funds or bond ETFs:
- Short-term investment-grade US bond funds
- Intermediate-term investment-grade US bond funds
- Short-term high-yield US bond funds
- Ginnie Mae bond funds
- Conservatively-allocated US balanced funds with 30% – 50% in stocks, the rest in bonds
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.