Welcome to the June newsletter! Today we’re going to cover pre-recession indicators, real estate IRAs, the US GDP, and much more. Let’s get started!
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
The US non-farm payroll rose 164,000 in April. The unemployment rate dropped to 3.9% – it’s lowest since the year 2000. When compared to a year earlier, wage inflation rose 2.6% in April 2018. The broadest measure of unemployment, U-6, dropped another 0.2% to 7.8%, which is very encouraging for Americans working in part-time jobs but are looking for full-time employment. Overall, these are “Goldilocks” results – not too hot and not too cold.
The Bureau of Economic Analysis (BEA) said first-quarter 2018 GDP was revised down slightly from 2.3% to 2.2%. However, this is still a very good GDP number compared to other recent first-quarters. The Atlanta Fed’s GDP forecast model is predicting second-quarter GDP at over 4%! The BEA will announce its actual second-quarter number in late July.
Commentary
With the above two announcements, it seems nothing can stop this economy! But, let’s discuss where the US GDP is heading over the next 20 to 30 years. In a very broad sense, GDP growth is tied to productivity growth and population growth. We’re doing OK increasing productivity, but our population growth is decreasing to dangerous levels.
For example, Japan is a country with a very significant population growth problem. Their birth rate is 1.4-lifetime births per female. Predictions are that by 2050, 40% of the Japanese population will be over the age of 65. These demographics will produce a country with an out-of-control annual budget and scary high tax rates to pay for an unsustainable welfare system. Therefore, this is not a country I want my children or grandchildren to live in.
In 1960, women in the US were having on average 3.7 births during their lifetime. Let’s compare that to the average 1.8 births for women in 2016. If this continues, the US economy will descend into deep doldrums for decades and may never recover. If nothing changes, the next world powers will likely be China and India.
Of course, each family must decide for themselves how many children they will have. It will be beneficial for the long-term economic growth in the US if current and future parents have more children than the current birth rate.
Stock Market
Commentary
This month let’s review our pre-recession indicators for any signs of a recession.
Accelerating Inflation – Inflation has finally approached the Fed’s target of 2%. Thankfully, we’re no longer close to de-inflation or negative inflation. Inflation has been rising to a normal level but not to a dangerously high level. There is no problem here.
Payroll Growth – Payrolls are growing nicely but down from the peak growth in 2015. Teen unemployment is at its lowest level since 2000. This is good news.
Rising Unemployment Claims – The trend of new unemployment insurance claims has been favorable in recent years, and the four-week moving average in May registered its lowest level since December 1969. Wow, this is great!
Inverted Yield Curve – When short-term rates exceed long-term rates, the yield curve is considered to be inverted. Since 1970, there have been seven recessions, and in every case, an inverted yield curve preceded the recession. With the 90-day Treasury at 1.95% and the 10-year at 2.9%, the yield curve is definitely not inverted. There is no issue here.
Leading Economic Indicators – On a year over year basis, the LEI has increased a robust 6.4%. This is the fastest pace since July 2014 and well above the historical gain per annum of 2.3%.
This economy is performing very nicely with no signs of a recession in sight.
High Turnover Funds Have a Hidden Cost
Lorenz Financial hopes all investors realize that all mutual funds and exchange-traded funds have an Annual Expense Ratio. This is an annual fee paid by the investor that covers most of the funds operating expenses. This fee is always expressed as a percentage and can range from 0.04% to over 2.50% per year.
In addition to the Annual Expense Ratio, there is another investor paid expense that is hidden. As the fund manager buys and sells stocks and bonds inside the fund, the fund accepts brokerage expenses from their broker. Here is a typical statement inside a mutual fund’s prospectus:
“The fund pays transaction fees and commissions when it buys and sells securities (or turns over its portfolio). A fund with a high turnover rate indicates higher transaction costs AND will also result in higher annual taxes owed by the investor when the Fund’s shares are held in a taxable account. These costs, which are NOT reflected in the Annual Expense Ratio of the fund, are paid for by the investor and reduce the Fund’s performance every year.”
So, high turnover funds cost investors more than low turnover funds. Well, what is a low turnover rate and what is a high turnover rate? Four percent is very low and 100% is very high. What are the Annual Expense Ratio and turnover rate of your funds?
So How Expensive Are Your Funds?
If you’re unsure about the costs of your funds, contact Mark at Lorenz Financial. We offer a free analysis of the costs of your mutual funds and exchange-traded funds. Just send us a list of the funds you own, including the ticker symbol if possible. With no cost and no obligation, we will show you the total cost structure of your funds. There is no benefit to having high-cost mutual funds in your portfolio!
Recommended Action for Your Stock Portfolio
All portfolios remain fully invested. There should be no selling during a correction. If a buy signal develops, 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
BFF
Most of you know how much Mark loves BIG cats. In the picture below, have you ever seen a happier lion? If you look close, you can see this lion is actually smiling. Mark would love to have at least one happy lion (or leopard or tiger or cheetah)!
After seeing this picture, how could anyone mistreat an animal?
Please Don’t Put Real Estate in Your Traditional IRA
Occasionally, someone might suggest to an investor to open a self-directed IRA and purchase rental income property inside the IRA. Lorenz Financial does NOT recommend this!
First, the investor cannot get a loan when purchasing property inside an IRA. The IRS says the investor must pay cash from the IRA for any property inside the IRA. Second, all maintenance, repairs, and property taxes must be paid from the IRA. The investor is not allowed to pay any bills with “outside” money.
At age 70½, the investor must begin to make annual Required Minimum Distributions (RMDs) unless the IRA is a Roth IRA. So, if all the IRA money is tied up in rental property, the investor will not have any cash to make the RMD. As all IRAs must have a custodian to manage the account, those few custodians who will manage a “Real Estate IRA” will likely require an annual fee of 1.5%.
Finally, if the property grows in value and is sold, the investor cannot take advantage of lower capital gains tax rates. All the money pulled out of the IRA will be taxed at higher income tax rates no matter how the money was invested inside the IRA. Real estate can be a good investment, but not inside an IRA.
Bond Market
Commentary
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 Federal Open Market Committee’s next meeting is June 12 and 13. We expect the FOMC to raise the Federal Funds rate another 0.25%. Assuming this short-term rate increase is made, the range of the Federal Funds rate will be 1.75% to 2.00%.
The Fed is also ramping up its program of quantitative tightening (QT) to increase long-term interest rates. Under this program, the Fed is allowing a portion of its balance sheet holdings to roll off as they reach maturity. In June, the Fed will permit up to $18B of US Treasuries and $12B of agency mortgage-backed securities to roll off its balance sheet. In July, the total amount of QT will increase from $30B to $40B per month. In October, the amount of QT will increase again to $50B per month.
US Treasuries
The Treasury is looking at selling a 60-day T-bill to complement the existing 30-day and 90-day Treasuries.
Inflation
The BEA announced the Personal Consumption Expenditure (PCE) was 2% in April compared to a year earlier. PCE, excluding food and energy, was up 1.8% in April compared to a year earlier. These inflation numbers were unchanged compared to a month earlier.
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 2.03%
10 Year 2.07%
30 Year 2.09%
Recommended Action for Your Bond Portfolio
Our bond market investments remain unchanged. We’re investing only in short-term, investment-grade bond funds, intermediate-term investment-grade bond funds, and short-term, high-yield bond funds.
We’re not recommending any long-term bonds or long-term bond funds. Municipal bond funds are not recommended at this time due to the risk of some US 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 a very high risk due to the recent strength of the US dollar, low yields and the risk of bankruptcy.