Welcome! Here are brief overviews of recent stock and bond market news and how they could be affecting your portfolios.
Economic growth grew at an annual rate of 2.6% in the 4th quarter. During the first four weeks of January, the stock market roared higher by 7.4%. Interest rates are also going up, which means the prices of existing bonds are dropping. No recession is in sight, and all portfolios remain fully invested.
A recession just doesn’t happen overnight. It has pre-indicators. Here is what Lorenz Financial is watching:
Accelerating Inflation: The year-over-year rate of inflation as measured by CPI is 2.1%. The core CPI is 1.8%. There are no problems with these inflation numbers.
Excessive Payroll Growth: The pace of job creation in December was 148,000 jobs. Unemployment is at 4.1%. The 12-month average of job creation in 2017 was 168,000 – well below the peak of 248,000 in early 2015. No problems here.
Rising Unemployment Claims: Jobless claims have declined, as January saw the largest drop in claims in 9 years. No problems with unemployment claims.
Inverted Yield Curve: An inverted yield curve occurs when short-term rates exceed long-term rates. During period when the yield curve maintains an upward slope, the risk of recession is very low. Now 3 month Treasuries are at 1.46% & 30 year Treasuries are approaching 3.0% giving us a normal yield curve. Every recession over the past 50 years has been preceded by an inverted yield curve.
Deteriorating Leading Economic Indicators: The conference Board Leading Economic Index increased 0.6% in December, following gains of 0.5% in November and 1.3% in October. Nine out of 10 indicators are up. No economic problems are on the horizon.
Our conclusion is there is minimal risk of a recession beginning in the next 12 months. The S&P 500 Index ended January at 2824. If 2018 operating earnings are $152 then the PE ratio is 18.5. This is nowhere near the stock market bubble of 1st quarter 2000 when the PE ratio was closing in on 30. We are not in a stock market bubble. We are in a stock market bull market with a high likelihood of a correction sometime this year of between -10% and -20%. After that the bull market will continue. A recession is not in sight.
S&P 500 Index Operating Earnings and Potential Going Forward
We are increasing our full year operating earnings from $150 to $152 per share. We are maintaining our price/earnings ratio range of 17.5 to 18 times operating earnings. This gives us a fair value of the S&P 500 Index of 2,660 to 2736. But the potential for the S&P 500 Index this year is in the 2900’s range given the penchant for stock prices to migrate into overvalued territory during an extended bull market.
International Stock Market Investing: Should you use an Index or a Managed Fund?
Many investors have found the benefits of index investing for the US stock market. Index investors get a high level of diversification, very low costs, market returns, and tax efficiency for taxable accounts. Unfortunately these advantages do not apply to international stock market index investing. An international stock index fund is going to have a large portion of its money invested in the major world markets including Europe, Japan, Canada and Australia. Many international index funds have 20 to 25% of their investment in Japan.
Unfortunately, when Japan went through a 19-year bear market losing 80.55% of its value from 1989 to 2009, international stock index fund investors lost 80% of their money on the 20-25% that was invested in Japan! A good international stock managed fund would have lost some money in Japan during this time but not to the extent the index fund lost.
Gross Domestic Product
Economic growth grew in the fourth quarter at a 2.6% annual rate. This number will be adjusted during the next two months. If left unchanged, 2017 GDP grew at 2.53%. This is significantly above the rate of 1.85% in 2016.
Recommended Action for Your Stock Portfolio
All portfolios remain fully invested. Lorenz Financial is diligently watching the stock market to see if a sell signal is warranted. So far it is not. Even if the late January downturn increases to -10% or -15%, for 99% of working investors the proper action is to sell nothing and continue monthly buying into your employer’s 401k or 403b, or 457 or TSP, PERF plan or IRA. For most retirees, the best plan is to ride out this downturn with no selling. If you are still worried, contact Mark at Lorenz Financial for a more thorough discussion.
Experts have been predicting a rise in interest rates for several years. With the 10-year Treasury now over 2.8%, Lorenz Financial believes the 35-year bond bull market is definitely over. This bond bull market started in September 1981 with the 10-year Treasury yielding 15.8%. In July 2016 the low-yield, high-price point was reached with the 10-year Treasury paying 1.36%. Remember as bond yield goes down, bond prices go up. This represents a bond bull market.
Now the opposite has begun, a bear market in bonds. Bond yields are going up with existing bond prices going down. Bonds are in a bear market for sure, but Lorenz Financial would not call this a bond bubble unless an investor is only considering long-term bonds. The longer the maturity of a bond, the greater its price will decrease during a bond bear market.
The Federal Reserve ended its 2-day meeting on January 31 without raising short-term interest rates. In the post-meeting statement, the FOMC members noted the labor market has continued to strengthen and the economy is expanding at a solid rate. FOMC members expect “economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate.”
To pull the U.S. economy out of the 2008-09 Great Recession, the Federal Reserve significantly lowered short-term and long-term interest rates. Now that the world economies are doing better, both short-term & long-term rates are on the increase. Starting in December 2015, the Federal Funds short-term rate has been increased five times by the Fed resulting in the current rate range of 1.25% to 1.50%.
The Fed purchased $4 trillion in treasury and mortgage backed bonds following the Great Recession to lower long-term rates. In the fourth quarter 2017, the Fed started selling off those bonds at a rate of $10B per month. During 2018, the rate of bond sales will increase $10B per quarter. Therefore, the 2018 second quarter selling rate will be $20B per month and the 2018 fourth quarter selling rate will be $50B per month.
As measured by the difference between Treasury bond yields and TIPS yield, inflation expectations can be seen below.
Treasury Bond Maturities Inflation Expectation
5 Year 1.98%
10 Year 2.11%
30 Year 2.15%
Recommended Action for Your Bond Portfolio
Our bond market investments remain unchanged. We are investing only in short-term investment-grade corporate bond funds, intermediate-term investment-grade corporate bond funds and short-term high-yield corporate 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.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
Need help with your portfolio?
Lorenz Financial is ready to help you! Check out our resources page on our website for great finance tips and information, and contact us today to get started on planning your financial future!
Lorenz Financial Services, LLC is a West Lafayette, Indiana fiduciary who offers financial planning and portfolio management services. If you have questions about who we are or our services, please contact us at (765) 532-3295 or email us.