Welcome to the July newsletter! Today, we’re going to review the continued drop in the unemployment rate, the recent change in the Federal Funds rate, and the increase in retail sales. Let’s get to it, shall we?
Summary
The stock market remains in a bull market even as the correction continues. The bond market is in a bear market, with interest rates slowly rising and existing bond prices slowly falling. Employees contributing to their employer’s retirement plan should continue with their weekly or monthly contributions. No recession is in sight, and all portfolios remain fully invested.
The Economy
US nonfarm payrolls rose 233,000 in May. The unemployment rate dropped to 3.8% — its lowest since 2000. Wage inflation rose 2.7% in May compared to a year earlier. The broadest measure of unemployment, U-6, dropped another 0.2% to 7.6%. This includes total unemployed plus total employed in part-time jobs but who want a full-time job. This was 8.4% in May 2017. The good news just keeps coming.
The increase in retail sales to 0.8% in May over the previous month continues to support the increase in consumer confidence and an increase in family income. The latter has increased as unemployment has decreased, and the recent tax bill has put more money into every employee’s pocket. Who said “the retail market” was dead?
The June FOMC meeting gave members an opportunity to share their economic 2018 and 2019 projections. See the following table.
| 2018 | 2019 | |
| Real GDP | 2.7 to 3.0 % | 2.2 to 2.6% |
| Unemployment | 3.6 to 3.7% | 3.4 to 3.5% |
| PCE Inflation | 2.0 to 2.1% | 2.0 to 2.2% |
| PCE Core Inflation | 1.9 to 2.0% | 2.0 to 2.2% |
| Federal Funds Rate | 2.1 to 2.4% | 2.9 to 3.4% |
The University of Michigan announced their Consumer Sentiment survey increased from 98.0 in May to 98.2 in June. The increase in June was muted by some fears of the impact on tariffs on the economy.
Stock Market
Commentary
The extended bull market that began in the spring of 2009 is entering its 112th month as the second-longest economic recovery in U.S. history. Since the March 9, 2009 S&P 500 Index closing low of 676.53, the index has gained 302%. Add in the approximate 2% annual dividends, and the total return through June 30, 2018 has been 320%.
S&P 500 Index Long-Term Performance 1932 – 2017
Here is a graph showing the performance of the S&P 500 Index over the past 86 years.
In the graph, the 2001-2003 bear market and the 2008-2009 Great Recession appear as minor downturns when viewed over the long term. Below, prior bull markets show up as positive % returns, and bear markets produce the negative % returns.
| June 1949 to Aug 1956 | (86 months) | Up 267% |
| Aug 1956 to Oct 1957 | (14 months) | Down 22% |
| Oct 1957 to Aug 1959 | (22 months) | Up 56% |
| Aug 1959 to June 1962 | (35 months) | Down 14% |
| June 1962 to Feb 1966 | (43 months) | Up 80% |
| Feb 1966 to Oct 1966 | (8 months) | Down 22% |
| Oct 1966 to Nov 1968 | (26 months) | Up 48% |
| Nov 1968 to May 1970 | (18 months) | Down 36% |
| May 1970 to Jan 1973 | (32 months) | Up 74% |
| Jan 1973 to Oct 1974 | (21 months) | Down 48% |
| Oct 1974 to Sept 1976 | (24 months) | Up 74% |
| Sept 1976 to Mar 1978 | (18 months) | Down 19% |
| Mar 1978 to Nov 1980 | (33 months) | Up 62% |
| Nov 1980 to Aug 1982 | (21 months) | Down 27% |
| Aug 1982 to Aug 1987 | (60 months) | Up 229% |
| Aug 1987 to Dec 1987 | (3 months) | Down 34% |
| Dec 1987 to July 1990 | (31 months) | Up 65% |
| July 1990 to Oct 1990 | (3 months) | Down 20% |
| Oct 1990 to Mar 2000 | (114 months) | Up 155% |
| Mar 2000 to Oct 2002 | (31 months) | Down 49% |
| Oct 2002 to Oct 2007 | (60 months) | Up 99% |
| Oct 2007 to Mar 2009 | (17 months) | Down 52% |
| Mar 2009 to Dec 2017 | (106 months) | Up 295% |
$10,000 invested in 1949 would be worth over $1M today minus taxes if in a taxable account.
What does all of this tell us?
The market goes up and goes down — but overall, the stock market is profitable over the long term.
Investors need courage for those months when the market is going down.
Investors need patience as it takes decades to build significant wealth over a lifetime.
Therefore, always invest in a highly diversified, low-cost. and tax-efficient portfolio. If you don’t know how to do this, call Mark at Lorenz Financial.
Recommended Action for Your Stock Portfolio
2018 S&P 500 operating earnings remain estimated at $152. 2019 earnings remain at $163. With our estimated PE ratio range of 17 to 18, as investors begin to look toward 2019, the S&P 500 Index has the potential to trade into the 2900s. (163 X 18 = 2934)
There is no shortage of uncertainties for the stock market. These include:
1) Protectionist trade measures
2) The risk of the Federal Reserve raising interest rates too high or too fast
3) Uncertainty regarding the November elections
4) The potential that the PE range of 17 to 18 is too high for a rising interest rate environment, and stock prices could collapse.
Even so, all portfolios remain fully invested. There should be no selling during a correction. A buy signal might develop. If this happens, Lorenz Financial will make a quick announcement. Until then, our recommendation for new stock market money is to dollar cost average every pay period.
Other Topics
Wells Fargo Update
Wells Fargo announced on June 5 that they are retreating from retail banking in the Midwest. The bank — scrambling to cut costs and dealing with a wave of scandals — just announced plans to sell all of their branches in Indiana, Michigan, and Ohio. Good job everyone for closing your Wells Fargo accounts!
Bond Market
Commentary
Our real-time economic indicators point to an acceleration in the pace of growth in the second quarter. The Atlanta Fed’s GDP growth estimate is 3.8% for the second quarter. The New York Fed is forecasting 2.8% for the second quarter. We are increasing our 2018 GDP growth estimate to the range of 2.4% to 3.0% for calendar year 2018.
The bear market in bonds continues. Investors should definitely not hold any long-term bonds or long-term bond funds. Long-term is defined as “duration” greater than seven years.
Federal Reserve
The latest increase in the Federal Funds rate should not be a surprise to anyone as the new Chairman, Jerome Powell, has been transparent about his bullish opinion regarding the trajectory of the U.S. economy. Since breaking from seven straight years of near-zero short-term rates during the Great Recession, the FOMC has now raised rates eight times — by a quarter percent on each occasion — since December 2015 to the range of 1.75% to 2.0%. The next FOMC meeting is July 31–August 1. No rate hike is expected at this meeting..
US Treasuries
The U.S. budget deficit increased 23% year over year to $532 billion during the October through May period. This was not unexpected as federal receipts fell approximately 11% due to the tax cuts and spending increased approximately 12% year over year. For the fiscal year ending this September 30, the Congressional Budget Office (CBO) estimates the budget deficit will be $804B, up from $665B in the previous year. Lorenz Financial argues we desperately need term limits for members of the U.S. Congress as they are more and more out of control.
Inflation
The Bureau of Economic Analysis announced the Personal Consumption Expenditure (PCE) was up 2.3% in May compared to a year earlier. PCE, excluding food and energy, was up 2.0% in May compared to a year earlier. These inflation numbers are up 0.3% and 0.2% respectively from the previous month.
As measured by the difference between Treasury bond yields and TIPS real yields, long-term inflation expectations can be calculated and are shown below:
Treasury Bond Inflation
Maturities Expectations
5 Year 2.06%
10 Year 2.11%
30 Year 2.11%
Recommended Action for Your Bond Portfolio
Our bond market investments remain unchanged. We are investing only in short-term investment-grade bond funds, intermediate-term investment-grade bond funds, and short-term high-yield 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 too many U.S, cities and/or states going bankrupt. 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.