Welcome to the March newsletter! Today, we’ll discuss the two leading potential indicators for a bear market, why the S&P 500 Index is better than the Dow Jones Industrial Average, when to listen to the news about the stock market, and more. Let’s jump in!
Summary
As of February 28, 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—assuming a satisfactory trade agreement is reached with China.
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 304,000 in January—another high number. The December payroll number of 312,00 was revised down to 222,000, and the November number of 176,000 was revised up to 196,000. The three-month average is 241,000. Unemployment increased to 4.0% as the partial federal government shutdown increased the quantity of unemployed workers. Average hourly earnings maintained a 3.2% increase in January compared to a year earlier. We have now had 100 straight months of employment growth.
Gross Domestic Product
Real gross domestic product (GDP) increased at an annual rate of 2.6% in the fourth quarter of 2018 according to the initial estimate. This number will be revised in late March. Real GDP increased 2.9% in the calendar year 2018 (subject to revision) compared to 2.2% in 2017.
Inflation
Annual inflation dropped slightly in November (the latest numbers available) 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 | 1.84% |
| 10 Year | 1.95% |
| 30 Year | 1.98% |
Stock Market
Commentary
The extended bull market run that began in the spring of 2009 has completed its 120th month in February as the second-longest economic expansion in United States history. The growth pace has slowed but is still on a positive pace. Since the S&P 500 Index closing low of 676.53 on March 9, 2009, the index has gained 311%. In addition, the index has generated average annual cash dividends of close to 2%, thereby producing a total return through February 2019 of 331%. If a person had $100,000 invested in the S&P 500 on March 9, 2009, they would now have $431,000 without adding any money to the account.
Will the following two leading indicators predict the next bear market?
1. The U.S. Treasury Yield Curve as of February 27 is below.
There is a slight dip in the Treasury yield curve at 2, 3, and 5 years, but this is not close to exclaiming, “The Yield Curve is inverted—here comes a recession!” In the ending days of February, the overall curve has steepened at 10, 20, and 30 years.
2. The Conference Board said the Leading Economic Index (LEI) decreased 0.1% in January, following no change in December and a 0.1% increase in November. The Board’s spokesperson said, “The U.S. LEI has now been flat essentially since October 2018. The Conference Board forecasts the U.S. GDP growth will likely decelerate to about 2% by the end of 2019.”
Neither the Treasury yield curve nor the LEI suggests the beginning of a near-term recession (within six to nine months
Stock Market Valuation
We now estimate 2019 S&P 500 operating earnings will come closer to the bottom end of our range of $165 than the top at $170. Our estimated price/earnings ratio range remains at 17 to 18 times operating earnings. Therefore, the high-end range for the S&P 500 Index this year is 2805 (165 X 17) to 2970 (165 X 18). Lorenz Financial predicts if the trade war with China is settled soon, the market will challenge the S&P 500 Index 3000 level within the year.
Recommended Action for Your Stock Portfolio
Lorenz Financial expects the bull market trend to remain intact at least into the first six to nine months of 2019. We regard the risk of a recession as minimal at this time. Our two key pre-recession indicators continue to suggest the economy will continue on a 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 at this time.
Why is the S&P 500 Index better than the Dow Jones Industrial Average?
The Dow Jones Industrial Average is a price-weighted index of 30 large U.S. stocks. The S&P 500 Index is a market cap weighted index of the 500 largest U.S. stocks. To Lorenz Financial, the S&P 500 Index is a much better index to follow.
There are two bad things about the Dow. First, it’s a price-weighted index. For example, say the Dow closed today at 25,064.
If tomorrow 29 stocks in the index had no price change, but the HIGHEST-PRICED stock, Boeing, moved up 2%, the Dow would end the day at 25,122.
However, if tomorrow 29 stocks had no price change but the LOWEST-PRICED stock, Pfizer, moved up 2%, the Dow would close at just 25,070.
25,122 vs 25,070! Why should we follow an index that is based on which stocks in the index went up—the higher priced stocks or the lower priced stocks?
The second reason Lorenz Financial does not follow the Dow is it tracks only 30 stocks. The S&P 500 tracks 500 stocks. Lorenz Financial’s conclusion is the S&P 500 is the better index. Therefore, to judge the performance of your ETFs and mutual funds, compare your investment returns to the returns of the S&P 500 Index, not the Dow.
A pompous loud-mouth or a wise prognosticator?
An investor reads two articles on the internet, or sees two talking heads on a cable financial channel, discussing what comes next for the stock market. One says, “Sell and button down the hatches!” The other says, “Buy more as the bull market continues!” Is either one believable? How can anyone tell?
Here are some clues an investor can use to determine which presenter might be believable.
- Is the presenter a paid spokesperson?
- Is the presenter biased because he or she wants you to buy something their company is selling?
- Has the presenter consistently had the same message the past 30 years? Is he or she a perpetual Perma-Bear or Perma-Bull?
- What is the education, experience, and registration of the presenter?
- Does the presenter support his or her theory with fundamental economic data and/or technical analysis, or just emotion?
- Is an acknowledgment ever published when the presenter is wrong?
- Is the presenter a fiduciary, an advisor required to always put the interests of the client first?
Hopefully the answers to these questions will give a listener clues as to the worthiness of a presenter.
Bond Market
Commentary
For all of the calendar year 2018, real GDP increased 2.9%. The incoming data indicates economic growth will be muted in the first quarter. This is attributed to the combination of the partial federal government shutdown and the ongoing trade negotiations.
Federal Reserve
The next Federal Open Market Committee (FOMC) meeting is on March 19 and 20. We do not expect any change to the federal funds rate at that meeting. The Fed reaffirmed “its judgment that inflation at 2%, as measured by the annual change in the price index for personal consumption expenditures” is consistent with its price stability mandate. The Fed presently estimates the longer-run normal rate of unemployment to be 4.4%.
U.S. Treasuries
The U.S. Treasury said the public debt has increased $1.250 trillion over the past year. Total Treasury debt now exceeds $22 trillion. Although the supply of U.S. Treasury bills, notes, and bonds continue to grow to pay for the debt, demand for Treasuries remains robust—thereby allowing interest rates to remain low.
Recommended Action for Your Bond Portfolio
Our bond market recommendations have changed. We’re investing only in the following types of bond funds or ETFs:
- Short-term, investment-grade bond funds
- Intermediate-term, investment-grade bond funds
- Short-term, high-yield bond funds
- High-quality money market funds
- Conservatively allocated balanced funds (50% to 70% in bonds, the rest in stocks)
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.