Welcome to the February newsletter! Today, we’ll discuss the passing of John C. Bogle, 2019 major market conditions, a guide to your social security, and more. Let’s begin!
Summary
As of January 31, the stock market recovery from the nasty December correction continues. Lorenz Financial believes this correction will end, and sometime in 2019, an all-time new stock market closing high will be established.
Employees should continue to make their weekly or monthly contributions to their employer’s retirement plan or IRAs. The economy continues to grow without runaway inflation, no recession is in sight, and all portfolios remain fully invested.
The Economy
Employment
U.S. nonfarm payrolls rose to 312,000 in December– a very high number. The November payroll number of 155,000 was revised up to 176,000, and the October number of 237,000 was updated to 274,000. The average from October to December is 254,000. Unemployment increased to 3.9% as more unemployed people have started to look for a job. Average hourly earnings increased to 3.2% year over year in December.
Interest Rates
At their January meeting, the Federal Open Market Committee (FOMC) kept the federal funds rate range at 2.25% to 2.5%. The FOMC stated they would be patient before raising rates again.
Inflation
Annual inflation dropped slightly in November to 1.8% from 2.0% as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, increased from 1.8% to 1.9% during the same time period. The Federal Reserve’s target for both is 2.0%.
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 | 1.70% |
| 10 Year | 1.85% |
| 30 Year | 1.91% |
Stock Market
Commentary
We view the S&P 500 Index closing low of 2351 on December 24, 2018, as the final low for the 2018 mid-term election year correction. This correction brought the S&P 500 Index down 19.8% on a closing basis from the high on September 20, 2018. Wow, that was a deep correction! But patience and courage kept us from selling. The result was the S&P 500 Index was only down 4.5% January 1 to December 31 last year
What does 2019 hold for the stock market? Lorenz Financial can safely say, no one knows. But let’s look at the major current economic indicators for 2019:
- Gross Domestic Product will likely come in at 2.0% to 2.6%.
- The 10-Year Treasury will have a yield of around 3%.
- Corporate earnings will likely be 5% or more compared to last year’s earnings.
Therefore, we believe the stock market uptrend that began on December 26, 2018, will continue through 2019, but at a slower rate than the recent performance.
Will these two leading indicators predict the next bear market?
The U.S. Treasury Yield Curve as of February 1 is below.
The Conference Board indicated the Leading Economic Index (LEI) decreased 0.1% in December, following a 0.2% increase in November, and a 0.3% decline in October. The Board’s spokesperson said, “The recent moderation in the LEI suggests the U.S. economic growth rate may slow this year. The LEI suggests the economy could decelerate towards 2 percent growth by the end of 2019.”
Neither the LEI nor the Treasury yield curve suggests a near-term recession.
Stock Market Valuation
Our estimate for 2019 S&P 500 operating earnings remains in the range of $165 to $170. Our estimated price/earnings ratio range is 17 to 18 times operating earnings. Therefore, the range for the S&P 500 Index this year is 2805 (165 X 17) to 3060 (170 X 18). Lorenz Financial predicts if the trade war with China is settled soon, the market will challenge the 3000
What’s the frequency of the S&P 500 Index being down multiple years in a row?
Looking at the 20th and 21st centuries, one time we had four consecutive down years:
- 1929 to 1932 (The Great Depression)
Two times we had three consecutive down years:
- 1939 to 1941 (The Great Depression)
- 2000 to 2002 (The Dotcom Bubble)
One time we had two consecutive down years:
- 1973 to 1974 (Bear market due to Arab Oil Embargo, UK bank crisis, the Nixon Impeachment, and the U.S. going off the gold standard)
So, what is the likelihood 2019 will be another down year following the down year of 2018? Lorenz Financial believes it’s unlikely 2019 will be another down year based on our positive economic conditions, growing corporate profits, the continuation of the federal income tax cuts, our gross domestic product continuing strong, our robust unemployment, and low inflation. However, we know as well as most, past performance is no guarantee of future results.
Recommended Action for Your Stock Portfolio
Lorenz Financial expects the bull market trend to remain intact at least into the first half of this year. We regard the risk of a recession as minimal at this time. Two key pre-recession indicators continue to suggest the economy will continue in 2019 on a growth track. Therefore, we recommend our investors’ stock market allocation should be fully invested in a low-cost, highly diversified, and tax-efficient manner at this time.
Remembering John C. Bogle
1929 – 2019
American investors have lost the fiercest advocate they may have ever had. John C. Bogle, founder of Vanguard Group and a crusader for investors’ rights for over four decades, died in January at the age of 89.
Jack, as he was known, had two major accomplishments in his life. First, he single-handedly invented index funds—which hold virtually every security in a given market—a practical and popular option for individual and institutional investors. He created the first index fund in 1975.
Paul Samuelson, the first American to win the Nobel prize in economics (1970), praised Jack in 2005 by saying, “The creation of the retail index fund is equal in importance as the invention of the wheel, wine, cheese, the alphabet, and the Gutenberg printing press.” Obviously, Professor Samuelson was a connoisseur of fine wine and cheese.
Second, Jack pushed and shoved mutual fund annual expense ratios down to the vanishing point—all to the betterment of investors.
Warren Buffett recently said, “Jack did more for American investors as a whole than any individual I’ve known. A lot of Wall Street is devoted to charging a lot for nothing. He charged nothing to accomplish a huge amount.”
Two years ago, Warren wrote in his annual letter to shareholders, “If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing. In his early years, Jack was frequently mocked by the investment industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me.”
When should I take Social Security?
If you have paid into the Social Security system for at least 40 quarters, you can take Social Security income at any time from age 62 to 70. The advantage of taking Social Security at 62 is your income starts immediately at that age, but at a lower amount than at your full retirement age (FRA). The advantage of taking Social Security at a later date is your income will be higher – approximately 7% to 8% per year. See the chart below for those with a full retirement age of 66.
Lorenz Financial’s general recommendation is to take Social Security at age 70 or when you need it—whichever occurs first. For those who want a detailed analysis of their Social Security income options, contact Mark at Lorenz Financial.
Bond Market
Commentary
For all of 2018, we expect Gross Domestic Product (GDP) to be around 3%. The Atlanta Fed predicts 4th quarter 2018 GDP to come in around 2.7%. The New York Fed is predicting 2.6% growth for the 4th quarter. Here are several data points that are guiding us for continued growth in 2019:
The Association of American Railroads reported rail volume finished the calendar year 2018 strongly. For all of 2018, total rail carloads increased 1.8% from the prior year.
The American Trucking Association’s Truck Tonnage Index rose 6.6% in 2018. The Port of Long Beach reports total inbound and outbound 20-foot containers increased by 4.6% in 2018. The Port of Los Angeles moved a record cargo amount in 2018, gaining 1.2% over the prior year.
We remain comfortable with our forecast for real GDP growth within a range of 2.0% to 2.6% in 2019.
Federal Reserve
The Federal Open Market Committee (FOMC) met on January 29 and 30. At that meeting, FOMC members voted unanimously to keep the federal funds rate unchanged at the range of 2.25% to 2.50%. In the post-meeting statement, FOMC members noted the global economy is slowing and inflation pressures are muted.
U.S. Treasuries
The U.S. Treasury expects to borrow more than $1T for the second year in a row. In 2018, total new issuance of Treasury Bills, Notes, and Bonds amounted to $1.34T, indicating a sharp increase from the $550B borrowed in 2017. Although the quantity of supply continues to grow, demand for treasuries remains robust—thereby allowing interest rates to remain fairly low.
Recommended Action for Your Bond Portfolio
Our bond market recommendations remain unchanged. We’re 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 funds. The latter should yield 2% or more annually.
We’re 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.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS