Happy New Year, and welcome to the January 2020 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.
The stock market seems to have shrugged off the wall of worry as 10 all-time new closing highs were achieved in December for the S&P 500 Index. Early comments out of Wall Street suggest corporate profits will be 8 to 9% higher in 2020. Most importantly, we believe the chances of a recession in 2020 are at best remote. All portfolios remain fully invested.
Employees should continue to make their weekly or monthly contributions to their employer’s retirement plan or IRAs. At this time, additional money can be added to an investor’s stock market allocation, but only on a dollar-cost-average basis.
U.S. nonfarm payrolls rose in November by 226,000. The October payroll number was revised up from 128,000 to 156,000. The September payroll number was revised up from 180,000 to 193,000. The rolling three-month payroll average increased from 176,000 last month to 192,000 this month. Even manufacturing jobs increased by 54,000 in November (following a decline of 43,000 in October due to the GM strike).
Over the past 12 months, average hourly earnings increased by 0.1% to 3.1%.
Gross Domestic Product (GDP)
The Bureau of Economic Analysis said the third estimate of GDP of the third quarter of 2019 was unchanged at 2.1%. The first quarter was 3.1% and the second quarter was 2.0%. It is good that we are holding GDP at or above 2.0%.
Annual inflation rose slightly in November to 1.5% from 1.4% 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|
Inflation numbers above are approximately 0.1% higher when compared to last month’s numbers.
The U.S. economy and stock market are in a great place. We have very low unemployment and 7 million open jobs. Nonsupervisory employees have seen 2x wage growth as compared to supervisory employees.
U.S. homeowners have continued to see the value of their home appreciate as well as their stock market portfolios. No wonder consumer sentiment is high.
The economy enjoys low inflation and low energy costs. On top of this, we have slow to moderate GDP growth. Importantly, investor euphoria, one of the most dangerous signs of excessive investor sentiment, remains relatively dormant. This bull market has climbed the wall of worry in 2019 amidst a healthy level of investor skepticism.
Will the following two leading indicators predict the next bear market?
1. The U.S. Treasury Yield Curve as of January 3 is below.
The short end of the yield curve remains very flat following the Federal Reserve’s three rate cuts in 2019. The inversion we had a few months ago is gone. The long end of the curve (the right side) has a very desirable steep slope.
2. The Conference Board said the Leading Economic Index (LEI) was unchanged in November.
The LEI spokesperson said, “The U.S. LEI was unchanged in November after three consecutive monthly declines. While the six-month growth rate of the LEI remains slightly negative, the index suggests the U.S. economic growth is likely to stabilize around two percent in 2020.”
Conclusion: The Treasury yield curve is NOT predicting a recession, and the LEI is suggesting the economic expansion will be in the 2% range in 2020. There are no signs today of a recession beginning in the next 6 to 9 months as based on the economic conditions as presented by these two indicators.
Stock Market Valuation
The S&P 500 index closed on December 31 at 3,230.78. For the year, the S&P 500 was up 28.88%. With the index paying approximately 2% in dividends for the year, the total return of the S&P 500 Index was up over 30% for the year. Please remember, past performance is no guarantee of future results.
Where do the big brokerage houses think the S&P 500 is going in 2020? Here is their current thinking:
|Bank of America||3300|
Our research has raised our thinking regarding the potential PE (price-earnings) ratio for the S&P 500. We have been using a range of 17 to 18. We now believe the range can extend to 19. Our projection for 2020 S&P 500 operating earnings is $177 a share, therefore, the S&P 500 index is likely to reach 3,363 in the foreseeable future: $177 x 19 = 3,363. Combine this with the big brokerage house thinking above, and a high range for 2020 looks like it could be 3,363 to 3,425.
Where did Piper Jaffray come up with 3,600? They assume corporate profits will be $180 with a PE ratio of 20: $180 x 20 = 3,600. This could happen, but please don’t count on it.
Recommended Action for Your Stock Portfolio
We expect periods of short-term stock market weakness to occur in 2020. When they do, we expect those periods of consolidation to be in the range of -5% to -9% from a recent high. During these short-term stock market pullbacks, we recommend NO SELLING, as within a month or two the market will be back to its recent high. On the other hand, if an investor has stock market cash available, stock market pullbacks have historically been a good time to BUY!
Broad Options for Conservative Investing
Over the past three months, we have been reviewing the broad options for our four categories of “conservative investing.” They are in order:
- 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 lower risk, lower volatility, and (over the long term) lower return investing. This month we will discuss medium risk, medium volatility, and (over the long term) medium return investing.
* Both “Savings” and “Very Conservative Investing” will very likely LOSE VALUE after taking into account taxes and inflation. We do not advocate “let’s plan on losing money with our investments after taxes and inflation.” See our formula below.
Real Return = (stated return x (1- marginal income tax rate)) – rate of inflation
For an example of this formula, contact Mark at Lorenz Financial for a copy of the October newsletter, or click here. Here are our categories for medium risk, medium volatility, and (over the long term) medium return investing:
- Long-term, investment-grade corporate and muni bond funds
- High-yield bond funds
- Multi-sector and non-traditional bond funds
- Convertible bond funds
- Balanced funds with moderate allocation (about 50% to 70% in stocks, the rest in bonds)
- Utility and high dividend stock funds
- U.S. real estate and global real estate funds
In general, these investments will produce a positive return over the long term, even after subtracting taxes and inflation from the return.
This concludes our series of “conservative investing.” If anyone missed the October, November, or December newsletters and would like to see our comments on the other three broad categories of “conservative investing,” please contact Mark.
The recent Federal Open Market Committee (FOMC) meeting has allowed the members to publish their latest thinking on key economic indicators for 2020. The list is below.
|Real GDP||2.0 to 2.2%|
|Unemployment||3.5 to 3.7%|
|PCE Inflation||1.8 to 1.9%|
|Core PCE||1.9 to 2.0%|
|Federal Funds Rate||1.6 to 1.9%|
The FOMC held a two-day meeting on December 10 and 11. At that meeting, FOMC members voted unanimously to maintain the federal funds target range at 1.5% to 1.75%. In the post-meeting statement, FOMC members noted, “The labor market remains strong, and the economic activity has been rising at a moderate rate.”
We do not expect any change in the federal funds rate at the January 28 – 29 FOMC meeting.
Congress reached an agreement on a bipartisan budget bill that funds the federal government through the end of the fiscal year (September 30, 2020). The bill was signed into law by President Trump. The bill allows for $49 billion in additional spending, and it includes a pay increase for military and civilian federal workers.
Recommended Action for Your Bond Portfolio
Jeffrey Gundlach, founder of DoubleLine Capital LP, said on CNBC on December 11, 2019, “Bonds make money slowly but lose money quickly.” He said personal and corporate debt is currently excessive. As the federal government spending continues to be out of control, during the next recession, federal government borrowing will climb sharply as the government’s tax receipts will sharply decrease. As a result, the dollar will weaken, and long-term interest rates will go up. Today, in Gundlach’s opinion, U.S. intermediate-term and long-term Treasuries have excessive interest rate risk — and corporate bonds, especially lower-rated bonds, have excessive credit risk.
All of this spells big trouble for many types of bonds during the next recession. Remember the BBB bond rating is the lowest rating for investment-grade bonds. Gundlach believes BBB-rated bonds and lower will see their prices decimated in the next recession as their creditworthiness drops.
For these reasons, our bond recommendations have changed significantly this month. We recommend owning only the following types of bond mutual funds or bond ETFs:
- Short-term and intermediate-term U.S. bond funds with a portfolio that consists of at least 60% securitized debt – debt backed by an asset
- Ginnie Mae bond funds
- TIPS bond funds
- Conservatively allocated balanced funds with 50% to 70% in bonds, the rest in stocks
In all cases, try to select a bond fund with an SEC yield over 3% and a duration of less than 4 years.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.