Welcome to the December 2019 newsletter! Today, we’ll update you on stock market changes, the Federal Reserve and Treasury, broad options for conservative investing, recommended actions for your stock and bond portfolios, and more. Let’s jump in!
Summary
The stock market seems to have shrugged off the absolute need to have a trade deal as it established another new all-time closing high. The U.S. and worldwide economic data we monitor remains weaker than earlier this year but is still positive. Most importantly, we believe a recession is not in the cards for the first half of 2020. All portfolios remain fully invested.
Employees should continue to make their weekly or monthly contributions to their employer’s retirement plan or IRAs. Additional money can be added to an investor’s stock market allocation, but only on a dollar-cost-average basis.
The Economy
Employment
U.S. nonfarm payrolls rose in October by 128,000. The September payroll number was revised up from 136,000 to 180,000. The August payroll number was revised up from 168,000 to 219,000 — a significant upward revision for both! The rolling three-month payroll average increased from 157,000 last month to 176,000 this month.
In the past 12 months, average hourly earnings increased by 3%.
Gross Domestic Product (GDP)
The Bureau of Economic Analysis revised the third-quarter GDP estimate from 1.9% to 2.1%. Most economists were expecting GDP to remain the same or be revised down, so this increase is a welcome surprise. We cannot have a recession if GDP is rising!
Inflation
Annual inflation remained unchanged in October at 1.3% as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, dropped to 1.6% from 1.7%. Even though the Federal Reserve lowered interest rates three times earlier this year, it takes time for those changes to work their way through the economy. Hopefully, those rate cuts will energize the economy in early 2020 and increase the rate of inflation closer to the Fed’s target of 2%.
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 | 1.50% |
| 10 Year | 1.61% |
| 30 Year | 1.71% |
The inflation numbers above were slightly higher than November’s results.
Stock Market
Commentary
Since the yield curve is no longer inverted (see below), we do not see the limited time in 2019 it was inverted as a precursor to a near-term recession. Below, we are updating our research into the five primary causes of a bear market, as well as our conclusion:
- Tight money: The federal funds rate has been reduced to its current range of 1.50% to 1.75% as a result of three rate cuts this year. The Federal Reserve has also implemented a new monthly U.S. Treasury Bill purchase program designed to provide copious levels of liquidity. The Quantitative Tightening balance sheet reduction program was terminated in September. As a result of these moves, there is no evidence the U.S. money supply is tight.
- Rising rates: The Federal Open Market Committee (FOMC) ended its Interest Rate Normalization and Quantitative Tightening programs earlier this year. The prospect of rising rates represents very little risk to stock market participants.
- High inflation: The preferred inflation index for the Federal Reserve is the Personal Consumption Expenditures index (PCE). The PCE shows a year-over-year increase of only 1.3%. The core PCE index, which excludes food and energy, has risen only 1.6%. Today, there is no “high” inflation.
- Rapid growth: The Leading Economic Indicators (LEI) declined by 0.1% in October. In the six-month period through October, the LEI decreased 0.1%, versus a growth rate of 0.4% in the previous six-month period. The sluggish readings in the LEI support our view that the low rate of economic growth is not likely to accelerate any time soon.
- Overvaluation: We are currently comfortable with our price/earnings ratio range estimate of 17 to 18 times operating earnings. Even though 16 times is considered normal, this higher valuation is underpinned by our current low inflation and low interest rates. We expect 2020 operating earnings for S&P 500 companies to be $177. This puts the S&P 500 index in the 3,200 range (177 x 18 = 3,186). The market closed at 3,113 on December 2, 2019.
Based on these findings, there are no economic indicators that lead us to believe a recession and bear market are on the horizon. We will continue to monitor the data for any significant changes.
Will the following two leading indicators predict the next bear market?
1. The U.S. Treasury Yield Curve as of November 29 is below.
The short end of the yield curve remains very flat following the Federal Reserve’s 25 basis point cut on October 30. The inversion we had a few months ago is now gone. Specifically, the 10 yr minus the 2 yr is now +17 basis points. The 30 yr minus the 5 yr is now +59 basis points, and the important 10 yr minus 3 months is +19 basis points. The yield curve is currently NOT inverted. The earlier Treasury yield curve inversion might have been a precursor to a pending recession, but that fear has totally evaporated.
2. The Conference Board said the Leading Economic Index (LEI) declined in October by 0.1% for the third consecutive month.
The LEI spokesperson said, “The major difference this month is the softening in the labor market — manufacturing remains weak and show no signs of improvement. The LEI now suggests the economy will end the year on a weak note, at just below 2 percent growth.”
Conclusion: The Treasury yield curve is no longer predicting a near-term recession, and the LEI is suggesting the economic expansion is slowing. There are no signs today of a recession beginning in the next 6 to 9 months, based on the economic conditions presented by these two indicators.
Stock Market Valuation
The S&P 500 Index closed at a new all-time high on November 27. This new high puts the S&P 500 Index up a whopping 34.1% since the bottom of the 2018 Christmas Eve stock market capitulation. We hope no one sold at the bottom.
We continue to expect short-term periods of market weakness to remain in the single-digit percentage area, which has been the case throughout 2019. The stock market is valued on the high side at this time, but not overly valued.
Recommended Action for Your Stock Portfolio
We recommend an investor’s stock market allocation should be fully invested in a low-cost, highly diversified, and tax-efficient portfolio as per the investor’s financial objectives, risk tolerance, and tax status. Additional money can be added to the stock market, but only on a dollar-cost-average basis.
Broad Options for Conservative Investing
Over the next few months, we will review the broad options for our four categories of conservative investing. They are in order:
- Savings
- Very conservative investing
- Lower risk, lower volatility, and (over the long term) lower return investing
- Medium risk, medium volatility, and (over the long term) medium return investing
Last month, we discussed very conservative investing. This month, we’ll talk about lower risk, lower volatility, and (over the long term) lower return investing.
Both savings and conservative investing will likely lose money after taking taxes and inflation into account. We do not advocate “let’s plan on losing money after taxes and inflation.” See our formula below.
Real Return = (actual return times X (1 – marginal income tax rate)) – rate of inflation
For an example of this formula, see October’s newsletter by clicking here.
Here are our categories for lower risk, lower volatility, and (over the long term) lower return investing:
- Long-term Treasury note funds
- Intermediate-term, investment-grade bond funds
- Short-term, high-yield bond funds
- Balanced funds with a conservative allocation (about 30% in stocks, the rest in bonds)
In general, these investments will produce a positive return over the long term even after subtracting taxes and inflation from the return.
Next month, we will discuss our final conservative investing option: medium risk, medium volatility, and (over the long term) medium return investing.
Pay on Death and Transfer on Death Options Have Been Expanded
Beneficiaries can now be added to car and truck titles in Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Illinois, Indiana, Kansas, Maryland, Missouri, Nebraska, Nevada, Ohio, Oklahoma, Texas, Vermont, and Virginia. See your state’s local DMV office for details.
Transfer on Death deeds for real estate are now available in Alaska, Arizona, Arkansas, California, Colorado, the District of Columbia (Washington, D.C.), Hawaii, Illinois, Indiana, Kansas, Michigan, Minnesota, Missouri, Montana, Nevada, New Mexico, North Dakota, Ohio, Oklahoma, Oregon, South Dakota, Virginia, Washington, West Virginia, Wisconsin, and Wyoming. To add or change a beneficiary, the deed MUST be submitted to the appropriate county recorder.
For more details, consult a lawyer in your state.
Bond Market
Commentary
As we look ahead to 2020, our initial forecast is for a slightly slower pace of real GDP growth. Although our forecast for economic growth is subject to developments in the ongoing trade war with China, we expect the overall pace of real GDP will be within the range of 1.8% to 2.2% in 2020.
Through the first 46 weeks of 2019, total combined U.S. rail traffic has fallen 4.5% from the same period in 2018. On the other hand, through the first 10 months of 2019, the Truck Tonnage Index is up 3.9% compared to the same period last year.
The Bureau of Labor Statistics reported the number of job openings has declined 277,000 to 7.0 million in September, which is the lowest number of job openings in 18 months.
Port traffic in Los Angeles has declined 19% year over year. October was the 12th consecutive month of lower U.S. exports. The Port of Long Beach also saw a drop of 5.4% of traffic during the first 10 months of 2019 compared to the same time in 2018.
In summary, we remain vigilant in our watch for early signs of an economic recession. Although the fourth quarter appears weak, we expect the three interest rate cuts by the Federal Reserve earlier this year will increase economic activity in 2020. There currently is no sign of a pending recession.
Federal Reserve
The Federal Open Market Committee’s (FOMC) next meeting is December 10 and 11. We do not anticipate any change in the federal funds rate at this meeting.
Fed Chair Powell noted in his remarks to Congress in November, “The economy is in its eleventh year of expansion. The unemployment rate is at a 50-year low. The economic risks are sluggish international growth and the ongoing trade dispute.” The Fed Chair went on to say, “The FOMC members see the current stance of monetary policy as likely to remain appropriate as long as incoming information about the economy remains broadly consistent with our outlook of moderate economic growth, a strong labor market, and inflation near our two-percent objective.” In other words, they have no plans to cut or raise interest rates.
U.S. Treasuries
Due to high borrowing needs for the foreseeable future, the U.S. Treasury is thinking about introducing a new 20-year Treasury bond in the fiscal year 2021. Currently, it offers a 10-year and a 30-year bond. The Treasury is also considering an ultra-long, 50-year bond. These new securities would allow the Treasury to increase the total amount of borrowing over a broader spectrum of maturities.
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 U.S. bond mutual funds or U.S. bond ETFs:
- Short-term, investment-grade U.S. bond funds
- Intermediate-term, investment-grade U.S. bond funds
- Ginnie Mae bond funds
- Conservatively allocated U.S. balanced funds with 30 to 50% in stocks, the rest in bonds
- In all cases, try to select a bond fund with an SEC yield over 3%.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.