Welcome to the July newsletter! Today, we’ll update you on the Federal Reserve and Treasury, how our most recent “buy” signals performed, recommended actions for your stock and bond portfolios, and more. Let’s get started!
Summary
The stock market’s December correction is over, as we have hit new all-time closing highs on April 30 and June 21. Key economic indicators show low inflation, moderate economic growth, low interest rates, and low unemployment. No recession is in sight, and all portfolios remain fully invested.
Employees should continue to make their weekly or monthly contributions to their employer’s retirement plan or IRAs. The economy continues to grow steadily without runaway inflation. Additional money can be added to the stock market at any time on a dollar-cost-average basis.
The Economy
Employment
U.S. nonfarm payrolls rose by 75,000 in May—much lower than expected. The April payroll number of 263,000 was revised down to 224,000, and the March number of 189,000 was revised down to 153,000. The three-month payroll average dropped from 169,000 to 151,000.
Unemployment remained at 3.6%, the lowest since December 1969. Total unemployed persons rose from 5.8M to 5.9M. In May 2019, the increase in “average annual hourly earnings” dropped from 3.2% to 3.1%.
The Federal Reserve said they expect 2019 unemployment to be between 3.6% and 3.7%, with 2020 unemployment between 3.5% and 3.9%.
Gross Domestic Product
The U.S. economy grew at an annual rate of 3.1% in the first quarter, based on more complete data than the second estimate last month. Nonresidential fixed investments, exports, state and local government spending, and residential fixed investments all rose. These were offset by revisions to personal consumption expenditures and inventory adjustments.
The Federal Reserve said they expect 2019 GDP to be between 2.0% and 2.2%, with 2020 GDP between 1.8% and 2.2%
Inflation
Annual inflation decreased again in May to 1.5%, as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, remained constant at 1.6% year over year during the same time period.
The Federal Reserve said they expect 2019 personal consumption expenditure inflation to be between 1.5% and 1.6%, with the core rate between 1.7% and 1.8%. For 2020, they expect the inflation rate to be 1.9% to 2.0%, with the core rate also between 1.9% and 2.0%.
We can determine long-term inflation expectations by calculating the differences between Treasury bond yields & TIPS real yields of the same maturities. Results are:
| Bond Maturities | Annual Inflation Expectations |
| 5 Year | 1.53% |
| 10 Year | 1.69% |
| 30 Year | 1.74% |
These inflation expectations dropped approximately 0.25% in the last 30 days.
Stock Market
Commentary
The S&P 500 Index closed on June 28, 2019 at 2941. The stock market has had quite a run since the December 31 close at 2506. The S&P 500 Index is now up 17.36% since December 31, 2018.
We continue to encourage our clients to be long-term investors by demonstrating courage to not sell when markets are low and displaying patience for future growth when markets are high. We suggest our investors ignore the volatility that sometimes occurs in the stock market.
Will the following two leading indicators predict the next bear market?
1. The U.S. Treasury Yield Curve as of June 28 is below.
There is a noticeable dip in the yield curve at 2yr, 3yr, 5yr, and 7yr. Those yields are below the yields at 1mo, 2mo, 3mo, 6mo, and 1 yr. What’s nice is the steep upward trend at 10 yr, 20 yr, and 30 yr.
2. The Conference Board said the Leading Economic Index (LEI) remained flat in May following a 0.1% increase in April and a 0.2% increase in March.
The LEI spokesperson said, “Positive contributions from financial conditions and consumers’ outlooks offset the weakness in stock prices and the manufacturing sector. While the economic expansion is now entering its eleventh year, the longest in U.S. history, the LEI clearly points to moderate growth of two percent by year-end.”
Conclusion: Neither the U.S. Treasury yield curve nor the LEI suggests the beginning of a near-term recession (within the next six to nine months).
Stock Market Valuation
We estimate the 2019 S&P 500 Index operating earnings will be $167. Our preliminary 2020 estimate is $175. Based on our price/earnings ratio range estimate of 17 to 18 times operating earnings, we’re increasing our S&P 500 Index target range to be in the 3100s. (175 x 18 = 3150)
Recommended Action for Your Stock Portfolio
Right now, we regard the risk of a recession as low. Our two key pre-recession indicators continue to suggest the economy will continue on a slow, but positive growth track in 2019. Therefore, we recommend investor’s stock market allocation should be fully invested in a low-cost, highly diversified, and tax-efficient portfolio.
Additional money should be added to the stock market on a dollar-cost-average basis.
How have our two most recent “buy” signals performed?
On Monday, November 26, 2018, we declared the stock market was “attractive for purchase.” On the previous Friday, November 23, 2018, the S&P 500 Index closed at 2632.56. On Friday, June 28, 2019, the S&P 500 Index closed at 2941.76. This represents an 11.75% increase in approximately seven months.
In our June newsletter (sent out on May 30), we said the stock market is at a “buying opportunity for those investors with cash and a desire to add to their stock market allocation.” On the previous day, May 29, the S&P 500 Index closed at 2802.39. On Friday, June 28, 2019, the S&P 500 Index closed at 2941.76. This represents a 4.97% increase in approximately one month.
Why will the future U.S. economic growth rate be limited to 2%?
Real annual gross domestic product (GDP) increases are essentially the sum of two factors: population growth and productivity growth.
The rate of U.S. population growth remains close to its lowest level in 80 years with an annual growth of only 0.7%. The current 30-year low in the U.S. birth rate is doing nothing to improve this number. The long-term productivity growth rate has been below trend over the past decade and remains well below its 30-year average of 2.6%. These factors will continue to limit real annual GDP growth to 2.0% or below.
Bond Market
Commentary
First-quarter 2019 GDP growth was 3.1%. The Atlanta Fed is now predicting real GDP growth of 1.5% in the second quarter. The New York Fed is predicting only 1.3% real growth. Most of the manufacturing data we monitor including rail, trucking, and port traffic all point to a slowdown in growth. We remain hopeful that the ongoing trade disputes with our major trade partners will deescalate and the pace of economic growth will improve.
Federal Reserve
The Federal Open Market Committee (FOMC) met on June 18 and 19 and voted to maintain the Federal Funds rate at 2.25% to 2.5%. The St. Louis Fed president was the lone vote to lower the funds rate by 25 basis points at that time. The FOMC’s next meeting is July 30 and 31. We expect the Fed to lower the Federal Funds rate by 25 basis points at that time. If the economy weakens before then, they might lower the Federal Funds rate by 50 basis points.
U.S. Treasuries
The 10-year U.S. Treasury bond has fallen in yield from 3.25% last November to 2.0% this June. This has caused bond and mutual fund prices to increase and the yield curve to flatten. With one or two rate cuts pending by the Fed, we believe this will cause the yield curve to steepen and the threat of a recession to fade.
Recommended Action for Your Bond Portfolio
Our bond market recommendations have changed since last month. We’re investing in the following bond mutual funds and bond ETFs:
- Short-term, investment-grade U.S. bond funds
- Intermediate-term, investment-grade U.S. bond funds
- Short-term, high-yield U.S. bond funds
- Ginnie Mae bond funds
- Conservatively allocated U.S. balanced funds (30% to 50% in stocks, the rest in bonds)
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.