Welcome to the December newsletter! Today we’ll go over why we believe the current bear market will soon become a bull, the housing market’s balancing act that inches it away from potential collapse, and long-term expected inflation rates. Let’s dig in!
2018 has been an unusual year in that stock market investors have endured two corrections. The current correction began with a market all-time closing high on September 20. A low was established on October 29. The retest of the low was November 20, 21, and 23—all during Thanksgiving week. On Monday, November 26, Lorenz Financial announced the market was “attractive for purchase.” We believe the stock bull market will now resume. We see the S&P 500 index rising to over 3,000 in 2019.
The bond market is in a bear market, with interest rates slowly rising and existing bond prices slowly falling over the long term.
Employees should continue to make their weekly or monthly contributions to their employer’s retirement plan or IRAs.The economy continues to grow successfully without runaway inflation. No recession is in sight, and all portfolios remain fully invested.
U.S. nonfarm payrolls rose 250,000 in October—a much higher number than expected. As you recall, September’s job growth was low at 134,000. Averaged together, the U.S. has added 192,000 jobs each during the past two months. U.S. employment continues to shine as “the biggest kid on the block.” Wage growth poked up to an annual rate of 3.1% in October. Finally, workers are beginning to see reasonable, but not runaway, wage growth.
Gross Domestic Product (GDP)
Real GDP increased at an annual rate of 3.5% in the third quarter of 2018, according to the second estimate released by the Bureau of Economic Analysis. For the first nine months of 2018, real GDP is up on average 3.3%.
Home price gains slowed in September for the sixth consecutive month, another sign that rising mortgage rates are helping to sap the momentum out of the housing market. Ralph McLaughlin of CoreLogic Inc, said, “Home prices have absolutely cooled. Interest rates have gone up and home prices have increased for two years. Combined, this has really tamped down home demand. I see this as a market coming into balance, rather than a market that’s on the brink of a collapse.”
Annual inflation remained constant in October at 2.0% as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, excluding food and energy, dropped from 1.9% to 1.8%.
Long-term inflation expectations can be determined by calculating the differences between Treasury bond yields and TIPS real yields of the same maturities. Results are:
Bond Annual Inflation
5 Year 1.77%
10 Year 1.97%
30 Year 2.04%
From 2009 through 2017, the total U.S. stock market index returned, on average, 16.01% per year as measured by the exchange-traded fund VTI. But, since 1926, the market has returned only 10% per year on average. Does this mean the next nine years will only return 4% per year to enable the past 9 years + the future 9 years to match the long-term average of 10% per year? We sure hope not. But, if it could happen, what should investors do now? Here are our recommendations:
- Reduce risk through a high degree of diversification. Please, put 12 eggs in 12 different baskets!
- Reduce costs. Both the costs of the investment products (think mutual fund annual expense ratios) and the costs of the advisor must be minimized. See the information below on how some advisors are lowering their fees.
- Maximize the tax efficiency of taxable accounts. This means reducing short-term capital gains and ordinary dividends and maximizing long-term capital gains and qualified dividends.
If you don’t know how to take these actions, call Mark at Lorenz Financial.
Will these two leading indicators predict the next bear market?
The Conference Board said the Leading Economic Index (LEI) increased 0.1% in October to 112.1 (2016 = 100), following a 0.6% increase in September and a 0.5% increase in August. The Board’s spokesperson said, “The index still points to robust economic growth in early 2019, but the rapid pace of growth may already have peaked. While near-term economic growth should remain strong, longer-term growth is likely to moderate to about 2.5% by mid- to late 2019.”
The yield curve remains with an upward slope. The US Treasury Yield Curve as of November 30 is below.
There are no signs of a near-term recession or bear market as measured by these two leading economic indicators.
Stock Market Valuation
Based on our conservative forecast of $170 in S&P 500 operating earnings in 2019, the index has the potential to trade into the 3,000 to 3,100 range next year based on our prices/earnings ratio range estimate of 17 to 18 times earnings.
We’re currently rating the S&P 500 Index “attractive for purchase” on any weakness near or below the mid-2,600s range. Above that level, we suggest a dollar-cost-average approach if adding to your stock market investments. We anticipate new record market closing highs in 2019.
Recommended Action for Your Stock Portfolio
Lorenz Financial expects the bull market trend to remain intact at least into the first half of next year. We regard the risk of a recession as minimal at this time. Two key pre-recession indicators continue to suggest the economy will enter 2019 on a growth track. Therefore, we recommend your stock market allocation should be fully invested in a low-cost, highly diversified, and tax-efficient manner at this time.
Some Advisors Finally Lowering Their Fees
Some big brokers have begun to trim fees for investment advice. Morgan Stanley management has lowered the maximum a Morgan Stanley advisor can charge a client from 2.5% per year to 2.0%. but, two percent a year is still outrageous! Voya Financial Advisors’ (formerly ING Bank) typically charge around 1.5% per year. That’s still shameful!
As per Cerulli Associates of Boston, the average client pays a fee structure as below:
We have lower fees than the averages as presented by Cerulli Associates above. Even so, Lorenz Financial’s fees are negotiable. Do you know what your advisor charges? Most investors do not know. Call Mark at Lorenz Financial and find out how we treat clients respectfully, with minimal expenses.
Our financial theme for the U.S. in 2019 is decelerating growth. Our initial forecast for real GDP growth next year is within a range of 2.0% to 2.6%. We expect the Fed will slow the rate of increases in the Federal Funds rate in 2019. If there are no changes, the Fed’s balance sheet will shrink from $4.1T at the end of 2018 to $3.5T by the end of 2019.
The Federal Open Market Committee (FOMC) met on November 7 and 8 and did not raise interest rates. Their next meeting is December 18 and 19. In this meeting, we expect the FOMC to raise the Federal Funds rate from the range of 2% to 2.25% to the higher range of 2.25% to 2.5%. The Fed’s post-meeting statement said, “The labor market has continued to strengthen, and economic activity has been rising at a strong rate.”
Five spending bills that amount to approximately 75% of the 2019 federal budget have passed the Congress and have been signed by the president. Seven bills remain to be passed. If they are not passed by December 21, a government shutdown might occur.
Recommended Action for Your Bond Portfolio
Our bond market recommendations remain unchanged. We are investing only in short-term investment-grade bond funds, intermediate-term investment-grade bond funds, short-term high-yield bond funds, and high-quality money market accounts. The latter should yield 2% or more annually.
We are not recommending any long-term bonds or long-term bond funds due to the current high interest-rate risk. Muni bond funds are not recommended at this time due to the risk of too many U.S. cities and states potentially going bankrupt due to unfunded pension obligations. Treasury bond funds and international bond funds are not recommended at this time due to their low yield. Bond funds that invest in emerging markets are very high risk due to the recent strength of the U.S. dollar, low yields, and the risk of bankruptcy.