Welcome to the November 2019 newsletter! Today, we’ll update you on the Federal Reserve and Treasury, broad options for conservative investing, recommended actions for your stock and bond portfolios, and more. Let’s jump in!
Summary
The trade war with China continues, but some signs suggest there is progress on a mini deal. However, the potential signing of that trade deal at the Asia-Pacific Economic Cooperation forum in Santiago, Chile during November 16-17 is off, as the conference has been canceled due to rioting in Chile.
Even so, the stock market seems to have shrugged off the absolute need to have a trade deal, as it established a new all-time closing high. The U.S. and worldwide economic data we monitor remains weaker than earlier this year, but it’s still positive. Most importantly, a recession is not in the cards for the end of 2019 or the first quarter of 2020. All portfolios remain fully invested.
Employees should continue to make their weekly or monthly contributions to their employer’s retirement plan or IRAs. Additional money can be added to an investor’s stock market allocation, but only on a dollar-cost-average basis.
The Economy
Employment
U.S. nonfarm payrolls rose in September by 136,000. The August payroll number was revised up from 130,000 to 168,000—a significant upward revision! The July payroll number was revised up from 159,000 to 166,000. The rolling three-month payroll average increased from 156,000 last month to 157,000 this month. Unemployment dropped all the way down to 3.5%—a 50-year low!
Gross Domestic Product
The U.S. economy grew at an annual rate of 1.9% after inflation in the third of quarter 2019. This is the Bureau’s first estimate of the third quarter. This quarter’s GDP reflects positive contributions from federal, state, and local government spending and exports.
Inflation
Annual inflation dropped in September to 1.3% from 1.4% as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, also dropped to 1.7% from 1.8%. All numbers represent changes from the same time one year ago.
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 | 1.44% |
| 10 Year | 1.54% |
| 30 Year | 1.62% |
The inflation numbers above were slightly higher than October’s results.
Stock Market
Commentary
Without the risk of a recession, the stock market should be able to maintain its gradual upward trajectory into next year, with normal short-term periods of profit-taking along the way. As has been the case throughout 2019, we expect pullbacks to remain within the single-digit percentage range for now. The technical health of the market remains favorable.
Will the following two leading indicators predict the next bear market?
1. The U.S. Treasury Yield Curve as of November 1 is below.
What a difference a month makes. The short end of the yield curve has become very flat following the Federal Reserve’s 25 basis-point-cut on October 30. The inversion we had a few months ago is now gone. Specifically, the 10 yr minus the 2 yr is now +17 basis points. The 30 yr minus the 5 yr is now +66 basis points, and the important 10 yr minus 3 months is +21 basis points. The earlier Treasury yield curve inversion might have been a precursor to a pending recession, but it has now dissipated.
2. The Conference Board said the Leading Economic Index (LEI) declined in September by 0.1%.
The LEI spokesperson said, “The U.S. LEI declined in September because of weaknesses in the manufacturing sector and the interest rate spread. The decline was partially offset by rising stock prices. Looking ahead, the LEI is consistent with an economy that is still growing, albeit more slowly, through the end of the year and into 2020.”
Conclusion: The Treasury yield curve is no longer predicting a near-term recession. The LEI is suggesting the economic expansion that began in 2009 is continuing but slowing. There are no signs today of a recession beginning in the next 6 to 9 months, based on the economic conditions presented by these two indicators.
Stock Market Valuation
The S&P 500 Index closed at a new all-time high on October 30. Closing highs are much more important than intra-day highs. This new high puts the S&P 500 Index up a whopping 29.5% since the bottom of the 2018 Christmas Eve total stock market capitulation. We hope no one sold at the bottom.
Between now and May-June 2020, we are expecting a greater chance of an upward move in the stock market (compared to the risk of a downside move) primarily due to the three interest rate cuts by the Federal Reserve this year. Interest rate cuts take months to filter through the economy. We believe the benefits of these cuts will begin to show up in the fourth quarter this year and the first two quarters of 2020.
We expect the 2020 S&P 500 operating earnings to reach $176. Using our current price-earnings ratio range of 17 to 18, the S&P 500 index has the potential to challenge the 3,200 level (176 x 18 = 3168). The S&P 500 index closed November 1 at 3,067.
Recommended Action for Your Stock Portfolio
We recommend an investor’s stock market allocation should be fully invested in a low-cost, highly diversified, and tax-efficient portfolio as per the investor’s financial objectives, risk tolerance, and tax status. Additional money can be added to the stock market, but only on a dollar-cost-average basis.
Commission-Free Trading
Schwab introduced commission-free online stock trading on October 7, 2019. E*TRADE followed suit the same day. That is wonderful! So, let’s also celebrate that Lorenz Financial has been commission-free and transaction-free since July 2016.
Broad Options for Conservative Investing
Over the next few months, we will review the broad options for our four categories of conservative investing. They are in order:
- Savings
- Very conservative investing
- Lower risk, lower volatility, and (over the long term) lower return investing
- Medium risk, medium volatility, and (over the long term) medium return investing
Last month, we discussed savings. This month, we’ll talk about very conservating investing.
Last month, we reminded our readers that an investor has only “made” money if they have had a positive return AFTER subtracting taxes and inflation. We do not advocate “let’s plan on losing money after taxes and inflation.” See our formula below.
Real Return = (actual return times X (1 – marginal income tax rate)) – rate of inflation
For an example of this formula, see last month’s newsletter by clicking here.
Here are our very conservative investing categories:
- Intermediate-term Treasury note funds
- GNMA bond funds
- Treasury Inflation-Protected Securities (TIPS) bond funds
- Short-term, investment-grade bond funds
WARNING! Very conservative investing will likely lose value after taxes and inflation. Please, everyone, minimize your savings and very conservative investing. We do not recommend putting any substantial amount of money in savings or very conservative investing unless the money is to be spent in the near term.
Next month, we will discuss medium risk, medium volatility, and (over the long term) medium return investing.
A Dirty Little Secret Fidelity Will Not Talk About
Some mutual fund companies have been trying to boost their valuations by buying shares of non-public companies such as We. In July 2018, Fidelity valued their We shares at $102. In March 2019, Fidelity marked down its We holdings to $54 a share. Lorenz Financial wonders which Fidelity mutual fund shareholders were taken to the cleaners by this move? Fidelity said, “We do not comment on Fidelity funds’ individual holdings.” Lorenz Financial does not sell ANY Fidelity mutual funds.
Bond Market
Commentary
The Federal Reserve Chair, J. Powell, emphasized in his news conference on October 30 that the Federal Open Market Committee (FOMC) is serious about achieving its 2% PCE inflation target for both the headline and core numbers. Currently, they are 1.3% and 1.7%, respectively. This means the FOMC is unlikely to hike interest rates until they achieve the 2% target over multiple months.
Federal Reserve
The Federal Open Market Committee (FOMC) met on October 29 and 30. At this meeting, the FOMC cut the Federal Funds rate by 25 basis points to the range of 1.5% to 1.75%.
This was the third rate cut this year by the Fed. Last September, the Fed was forecasting four rate increases for 2019! This is a swing to 1.75% lower rates from what was expected just a year ago. Fed Chair Powell said at his October 30 news conference, “Our current interest rate policy is likely to remain appropriate as long as the economy expands moderately and the labor market stays strong.” In other words, the Fed is going to pause cutting interest rates unless multiple economic indicators spike persistently, indicating the U.S. economy is in trouble. The next FOMC meeting is December 10 and 11.
U.S. Treasuries
The U.S. Treasury released the final federal deficit numbers for fiscal year 2019. The deficit hit $984.B. Total federal spending increased by $339.B to $4,447B. Total federal borrowing increased by $1.05T.
Recommended Action for Your Bond Portfolio
Our bond market recommendations have slightly changed since last month. We are recommending bond investors only participate in the following types of U.S. bond mutual funds or U.S. bond ETFs:
- Short-term, investment-grade U.S. bond funds
- Intermediate-term, investment-grade U.S. bond funds
- Ginnie Mae bond funds
- Conservatively allocated U.S. balanced funds with 30 to 50% in stocks, the rest in bonds
- In all cases, try to select a bond fund with an SEC yield over 3%.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.