Welcome to the May 2023 Newsletter. This month, we’re discussing the economy, employment, financial terminology, and more.
Summary
The latest Federal Reserve Beige Book on the state of the U.S. economy shows little has changed in overall economic activity in recent weeks with Federal Reserve districts reporting growth at a modest pace. Consumer spending was generally flat to down slightly. Auto sales have remained steady, while travel and tourism picked up across the country. Manufacturing activity was reported as flat. Bank lending volumes and loan demand have slowed. Labor market conditions are easing as indicated by rising unemployment insurance claims.
The S&P 500 Index’s bottom in 2022 in this cycle was established as four nearly identical closing lows over a two-week period:
- September 30, 2022 at 3,585
- October 11, 2022 at 3,588
- October 12, 2022 at 3,577
- October 14, 2022 at 3,583
Since that time, the market has maintained an uptrend. But this year-to-date uptrend has been led by only five very large technical stocks (Apple, Microsoft, Meta, Amazon, and NVIDIA). Most stocks have not been in an uptrend so far this year. So, what is likely to follow and what is our mid- to long-term expectation?
Based on our 2024 S&P 500 operating earnings estimate of $245 per share—and our estimated PE ratio of 18 to 20 times the operating earnings—we expect the index to trade into the mid to upper 4,000s range by next winter. We also believe the index will challenge the 5,000 level during the 2024 calendar year.
In the short-term, we rate the stock market attractive for purchase on any weakness below the S&P 500 level of 3,700. But how likely are we to retest the October 2022 lows or even reach 3,700?
In the event the Federal Reserve is able to lead the economy to a soft landing (no recession), we think it is unlikely the S&P 500 Index will retrace it steps back to the October lows as listed above. With the S&P 500 Index above 3,700, we prefer investors with new money, dollar cost average into the stock market.
For now, that is the best advice we can offer as there are so many negative economic indicators as follows:
- The Fed continues to raise interest rates and will likely do so again on May 3.
- The Leading Economic Indicator has been negative now for 12 months in a row.
- The Yield Curve has been inverted for over a year.
- Gross Domestic Production is inching down.
- We have now had four major bank failures across the country.
- The Conference Board’s Consumer Confidence index fell in April to 101.3 from 104.0 in March.
All of these are bad and in support of a pending recession. If we do have a recession, the stock market could retreat to S&P 500 3,700 or even down to the October lows.
At this time, portfolios are 50% to 80% invested in the stock market and based on each investor’s objectives, risk tolerance, and time frame. The rest remains in cash. We could recommend at any time reinvesting cash back into the stock market. We recommend employees continue to save every pay period in their employer’s retirement plan and in a Roth IRA for their spouse and themself.
Quote of the Day
Thomas Edison
“Opportunity is missed by most people because it is dressed in overalls and looks like work.”
Thomas A. Edison (February 1847 to October 1931) was an American inventor and businessman. He developed many ideas including the electric power generator, electric light bulb, telephone, phonograph, and motion picture. Edison was the first inventor to apply the principles of organized science and teamwork to his pursuit of inventing new things. With 1,093 U.S. patents in his name, Edison is regarded as the most prolific inventor in American history. One of the many companies he founded was General Electric.
Pop Quiz
How many years of earned income are included in Social Security’s calculation to determine a person’s retirement income?
If a person has fewer than that number of years of income, how does the Social Security Administration change their calculation?
The answer is at the bottom of the newsletter.
The Economy
Employment
Total U.S. nonfarm payroll employment rose in March by only 236,000 while the official unemployment rate, U-3, dropped slightly to 3.5%. The January 2023 and February 2023 combined employment numbers were revised down by 17,000.
The Job Openings & Labor Turnover Survey (JOLTS) decreased to 9.9 million open jobs across the country as of the last business day in February. This compares to 10.8 million open jobs the month before.
The seasonally adjusted Total U.S. Unemployment Rate, U-6, decreased in March to 6.7% versus 6.8% last month. There were 6.0 million people unemployed in March—age 16 and older—compared to 6.5 million last month.
The following chart is based on the Bureau of Labor Statistics official unemployment rate, U-3.
Unemployment Rates by Education Level, March 2023
| Less Than High School Diploma | 4.8% |
| High School Graduate, No College | 4.0% |
| Some College or Associate's Degree | 3.0% |
| Bachelor's Degree or Higher | 2.0% |
Average hourly earnings of all employees on private nonfarm payrolls were up 4.2% compared to a year ago. This compares to a 4.6% increase last month compared to a year earlier.
Leading Economic Indicators (LEI)
The LEI for March dropped by a whopping -1.2%. This is not good! Below are previous monthly LEI results:
- February '23 -0.3%
- January '23 -0.3%
- December '22 -0.8%
- November '22 -0.8%
- October '22 -0.9%
- September '22 -0.5%
- August '22 -0.1
- July '22 -0.5%
- June '22 -0.7%
- May '22 -0.4%
- April '22 -0.4%
- March'22 +0.1%
- February '22 +0.6%
- January'22 -0.5%
With 12 negative consecutive monthly readings, the LEI continues to signal a recession in the near term. The Conference Board said, “The weaknesses among this index’s components were widespread in March.” The Conference Board continued with, “Economic weakness will intensify and spread more widely throughout the U.S. economy over the coming months, leading to a recession starting in mid- 2023.”
Gross Domestic Product (GDP)
The Bureau of Economic Analysis said the advance estimate for GDP in the first quarter of 2023 was at an annual rate of +1.1%. That was a significant drop from the previous quarter of +2.6%. The 1.1% increase was due to increases in consumer and federal government spending. GDP results in 2022 were a decrease of 1.6% in the first quarter, a decrease of 0.6% in the second quarter, an increase of 3.2% in the third quarter, and an increase of 2.6% in the fourth quarter.
In the chart below, we see a disappointing downward trend in GDP over the previous three quarters.
Inflation
Annual inflation decreased in March to 4.2% as measured by the Personal Consumption Expenditures (PCE) index. The previous month was 5.1%. That was a significant and welcomed decrease. But the core PCE index—which excludes food and energy—disappointed everyone by dropping only slightly to 4.6% in March from 4.7% in February.
The core PCE index is the most favored inflation index by the Federal Reserve, so that is the one we watch the most. With core PCE not going down in any significant way, we can count on the Fed raising short-term interest rates again at their next meeting (May 2 & 3).
Here is a bit of history for core PCE inflation this cycle:
- March '23 4.6%
- February '23 4.7%
- January '23 4.7%
- December '22 4.6%
- November '22 4.8%
- October '22 5.1%
- September '22 5.2%
- August '22 4.9%
- July '22 4.7%
- June '22 5.0%
- May '22 4.9%
- April '22 5.0%
- March '22 5.2%
- February '22 5.3% (peak PCE core inflation this cycle)
Only when we have steady and consecutive decreases in core PCE inflation, will the Federal Reserve be encouraged to stop raising interest rates.
The Public Debt as Issued by the U.S. Treasury, March 31, 2023
$31,712,027,000,000.
Last month it was $31,651,668,000,000. Why did the debt grow so little in the past month? Because the debt has reached the official debt limit and the U.S. Treasury is taking “extraordinary measures” to not exceed it.
Important Dates in May
May 1 – In 1889, comrades gathering at the International Socialist Conference declared May 1 would be an international holiday for labor. May 1 is not a holiday in the U.S., but it is across Europe.
May 2 – Primary election day in Indiana and elsewhere.
May 2 & 3 – The third Federal Open Market Committee (FOMC) meeting of 2023.
May 4 – May the fourth be with you.
May 5 – Cinco de Mayo. In the United States, this date has evolved into a commemoration of Mexican culture and heritage.
May 6 – The Kentucky Derby.
May 8, 1945 – VE Day or WWII’s Victory in Europe Day.
May 14 – Mother’s Day occurs on the second Sunday in May.
May 20 – Armed Forces Day occurs on the 3rd Saturday in May.
May 28 – The Indianapolis 500.
May 29 – Memorial Day. This day was originally called Decoration Day. After the Civil War, this day was set aside for family members and the public to decorate the graves of the soldiers who died in that war. After World War I, the holiday was expanded to honor all American war fatalities. The name Memorial Day became more commonplace after World War II.
The Stock Market
Commentary
This month we will hear from three Wall Street strategists and a spokesperson from the International Monetary Fund.
Chris Harvey
Harvey is the Head of Equity Strategy for Wells Fargo Securities in New York.
Harvey said on CNBC on April 11, “We are expecting a 10% correction in the S&P 500 Index in the next three to six months from yesterday’s close of 4,109.”
Savita Subramanian
Savita is the head of U.S. Equity & Quantitative Strategy at Bank of America’s Global Research.
Savita said in mid-April, “Before equity bulls start to celebrate about a Fed pivot, remember that easy Federal Reserve policy (when it comes) and credit tightening has been the worst phase for stocks.”
Brian Belski
Brian is the Chief Investment Strategist for BMO Capital Markets.
Belski has been one of the most bullish (optimistic) guys on Wall Street. But on April 10, Brian said on CNBC, “For the first time in many years, our enthusiasm for the stock market this year is relatively tempered.”
The International Monetary Fund headquarters in Washington DC.
The International Monetary Fund said in their World Economic Outlook, “Risks to the near term are heavily skewed to the downside, with the chances of a hard landing have risen sharply.”
Stock Market Valuation
One way to judge where the stock market value is is to multiply estimated corporate earnings times the estimated Price/Earnings ratio. For example, as of April 28, the S&P 500 Index looks like this:
4,169 (April 28 close) = $210 of estimated earnings x 19.85 PE ratio
A PE ratio of 20 during a time of rising interest rates is a very high number. Another way to say this is “today the stock market is highly priced”. During a recession, we could see the PE ratio drop to 17 or lower.
Now let’s look at the earnings picture for 2023. All the big banks have stock strategists who are trying to estimate this number. Here are some current projected corporate earnings per share of the S&P 500 companies:
- Goldman Sachs $224
- Citigroup $213
- Wells Fargo $210
- JPMorgan $205
- Bank of America $200
- Barclays $200
Let’s pick a number in the middle, say in 2023 the S&P 500 will have $210 of corporate earnings. And if the market PE ratio drops to 17 during the expected upcoming recession, the S&P 500 would drop to 3,570.
3,570 = 210 x 17
3,570 also happens to equal the October 2022 lows!
Of course, these estimates may or may not come to fruition. But it is this logic that is causing us concern: the Fed is increasing interest rates, loans by banks will likely become more difficult to obtain for people and corporations, unemployment is flat today (but we believe it will begin to increase), consumers will reduce spending, corporate profits will drop, and the stock market will go down from current levels.
We cannot guarantee this will happen nor can we guarantee it will not happen, but we have prepared ourselves for this likely event.
The S&P 500 Index closed on April 28, 2023, at 4169.48.
Monthly Performance of the S&P 500 Index
Recommended Action for Your Stock Portfolio
At Lorenz Financial, we try very hard to pick the best sectors of the stock market, but we know we're not perfect. We also try to identify the likely worst places to be and tell everyone to avoid it.
In our opinion right now, the worst place to put money is in high yield bond funds, also called junk bond funds. Why is this so bad right now?
Junk bonds are a high-risk place to put your money right now because banks are revising their lending standards in two ways:
1. Banks are raising their interest rates for new loans, and
2. Banks are tightening their standards for making new loans – meaning some of the most vulnerable companies, who have issued junk bonds, will not be approved in the near-term for new loans.
Both of these changes will put significant financial pressure on these companies. It is these same marginal companies that have issued high yield (junk) bonds in the past. We expect in the next six to twelve months more companies than normal will go out of business as they succumb to these tightening financial pressures.
If an investor has a position in high yield bonds, perhaps in a mutual fund or ETF, we recommend selling this asset class immediately and put the proceeds in cash.
Financial Markets Vocabulary
Last month we talked about the company Morningstar, and what their star rating system means. This month we will discuss Morningstar’s “Analyst Ratings”.
As we mentioned last month, the Morningstar Star rating system reflects a fund’s historical performance. It has nothing to do with projecting the fund’s performance going forward. The Morningstar Analyst Rating is just the opposite – it is all about the results of Morningstar’s forward-looking analysis – which of course could be right or wrong. Together, the two ratings provide a historical perspective and a future projection of a mutual fund’s or exchange traded fund’s performance.
The Analyst Rating is expressed as: Gold, Silver, Bronze, Neutral, Negative, or not rated. Gold is the highest and Negative is the lowest rating. Gold, Silver, and Bronze rated funds are expected to outperform similar funds over the long-term.
The Analyst rating is a combination of Morningstar’s evaluation of a fund based on Morningstar’s five key pillars – process, performance, people, parent, and price.
The most unfortunate aspect of the Morningstar Analyst Rating is it is only available with a subscription to Morningstar Premium service at $34.95 per month or $249 per year. Lorenz Financial subscribes to the premium service so if anyone wants to know an Analyst rating for a fund, just contact Mark and he will provide it at no charge or obligation.
OK, Now What Do I Do?
This is the final part of our four-part series on, “Know Your Financial Numbers”. Here are questions 17 through 22 for you and your spouse. You both should know these numbers. If you don’t, Lorenz Financial suggests, please spend some time, and determine your numbers!
Credit Score & Debt
17. What is your FICO credit score?
18. All debt is bad debt except a fixed-rate first mortgage. How much bad debt do you have?
19. When will you have all your bad debt permanently paid off?
20. In what year will you have your fixed rate first mortgage paid off?
Risk & Asset Allocation/u>
21. What is your risk tolerance for your portfolio on a scale from 1 to 100?
1 – Very Conservative
Only buy FDIC insured CD's from a local bank.
Very Aggressive – 100
100% of portfolio is in U.S. & foreign stock markets
Hopefully no one is a “1” or a “100”.
Comment: For a family’s portfolio – just to stay even with inflation and taxes but have no real growth, the portfolio should contain 30% to 35% participation in the stock market as a minimum over the long-term. If growth is desired over the long-term, participation in the stock market to at least 50% will be necessary.
22. What is your desired asset allocation in % for your broad portfolio for each category below:
| U.S. stocks | % |
| International Stocks | % |
| U.S. bonds | % |
| International bonds | % |
| Cash and cash equivalents such as CDs and I-bonds | % |
| Real estate (other than your home) | % |
| Other | % |
| TOTAL | % |
Our Financial Bad Boy This Month
The Supreme Court Takes Up “Home-Equity Theft”
Source: The Wall Street Journal, April 22-23, 2023, pages A15
Ms. Tyler of Minneapolis, Minnesota, today at 94, had her troubles begin when she moved into a senior residence in 2010 and fell behind on her property taxes. She ended up owing Hennepin County (the Minneapolis area) roughly $2,300 for property taxes on her condo. After tacking on penalties, interest, and related costs, her debt ballooned to $15,000. To collect what it was owed, Hennepin County seized and later sold her one-bedroom condo for $40,000.
You might think the county would settle the $15,000 debt and return the $25,000 balance to Ms. Tyler. But the county confiscated all of the $40,000 and left her with nothing.
Unfortunately, this action is pervasive. For example, in Massachusetts, the government took $56 million in home equity between August 2013 and July 2014, according to research by University of Massachusetts law professor Ralph Clifford.
Minnesota, Massachusetts, Nebraska, nine other states and the District of Columbia regularly seize such windfalls when collecting delinquent property taxes. But perhaps not anymore. Ms. Tyler’s lawsuit has now reached the Supreme Court. Oral arguments were heard in late April. We're hoping for a 9-0 vote in favor of Ms. Tyler and a strong admonishment for those 12 states and the District of Columbia that allow such thievery. We deserve better from our state and county governments.
The Bond Market
Commentary
The Federal Reserve controls the monetary base, which includes the amount of cash that circulate in the economy, along with bank reserves. Through year ending March 31, the monetary base—called M-1—has declined 14.2% after being adjusted for inflation. The aggregated money supply, called M-2, has declined 9.1% in the past 12 months. These declines reflect the Federal Reserve monetary tightening effort over the past year as they try to rein in inflation.
Recommended Action for Your Bond Portfolio
This month our recommendations for an investor’s safe money has not changed.
- Very Short-Term Investment-Grade bond fund
- Short-Term U.S. Corporate or Securitized bond funds
- Certificates of Deposit (only if FDIC or NCUA insured)
- U.S. Savings I-Bonds (max savings is $10,000 per account per year)
- Cash (in a money market mutual fund paying 4.25% to 4.8% per year)
PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS.
Pop Quiz Answer
How many years of earned income are included in Social Security’s calculation to determine a person’s retirement income?
Answer: The Social Security Administration bases their retirement income calculation on a person’s highest 35 years of earnings.
Say a person had only 25 years of earned income and not 35, how does the Social Security Administration modify the calculation for this person?
Answer: In this example, they will add in ten zeros!
Conclusion: If a person wants a competitive retirement income – which includes Social Security income – please plan on working at a full-time job for at least 35 years.