Welcome to the September newsletter! Today, we’re going to review what can end a stock bull market, recession indicators, and estate planning. Let’s jump right in!
Summary
The stock market correction that started on January 29, 2018 is now over and the bull market continues! The bond market, though, is in a bear market, with interest rates slowly rising and existing bond prices slowly falling.
Employees should continue to make their weekly or monthly contributions to their employer’s retirement plan or IRAs as the economy continues to grow successfully without run-away inflation. No recession is in sight, and all portfolios remain fully invested.
The Economy
Employment
U.S. nonfarm payrolls rose 157,000 in July (a surprisingly low number), but manufacturing added 37,000 new jobs in July—a higher number than expected. May payroll numbers were revised up from 244,000 to 268,000 and the June numbers were revised up from 213,000 to 248,000. Wage inflation in July rose 2.7% compared to a year ago. This number was unchanged from June. The unemployment rate decreased from 4.0% to 3.9%.
Gross Domestic Product
The Commerce Department said the second quarter GDP was revised up from 4.1% to 4.2%. The GDP annual growth rate after inflation for the first six months of 2018 is now at 3.2%. Compared to the last 10 years, this is a very good number.
Inflation
The PCE inflation index rose 2.31% year over year in July. The core index, excluding food and energy, rose 1.98% year over year in July. Both numbers were up 0.1% from the previous month. Core PCE inflation is now at the Federal Reserve’s target of 2%.
Long-term inflation expectations can be determined by calculating the differences between Treasury bond yields and TIPS real yields of the same maturities. Results are:
Bond Annual Inflation
Maturities Expectations
5 Year 1.98%
10 Year 2.08%
30 Year 2.11%
Home Prices
The S&P Case-Shiller national home price index posted a 6.2% annual gain in June compared to a year ago. This is down slightly from the 6.4% in May compared to a year earlier. Rising mortgage interest rates and the previous increase in home prices over the past two years is beginning to slow the growth of home prices.
Consumer Confidence
Consumer confidence dramatically rose in August. Factors including a buoyant job market and rising incomes are helping Americans feel better about the economy. The Conference Board’s director said, “Overall, these historically high confidence levels should continue to support healthy consumer spending.”
Stock Market
Commentary
At Lorenz Financial, we put a greater emphasis on stock market closing highs and lows as opposed to intraday highs and lows. For the first time since the January 26, 2018 market high, a new closing high of 2,874.69 was established on August 24. This has been a seven-month stock market correction from high to low and now back to a new high. This seven-month period is just another example of why investors need to have patience and courage to be successful over the long term.
The current bull market has now returned over 320% since March 2009. Also, each year the stock market has given investors approximately a 2% annual dividend. So, is this market finished or ready for another leg up? Well, what is the status of the economy? We have:
- Strong corporate earnings
- Very high Gross Domestic Product growth
- Low unemployment
- Stable inflation
- Strong consumer spending and consumer confidence
- Corporate and personal tax cuts just going into effect in January 2018
- Increasing but still accommodative interest rates from the Federal Reserve
There are no guarantees, and this is not the time to increase risk in your portfolio, but things are looking good for the next twelve months.
So, let’s take a look at what can kill a stock bull market. Lorenz Financial is closely watching two things.
1. Is the Federal Reserve raising short-term interest rates too much or too fast? This would begin to happen if the yield curve inverts. This means short-term interest rates are higher than long-term interest rates. Here is the yield curve as of August 28, 2018.
Due to the long-term rates being higher than the short-term rates, there is no inverted curve as we would expect.
2. What if the U.S. economy goes into a recession?
This is likely to happen if the Leading Economic Index—LEI—turns negative. But take a look at what the LEI is doing now.
There will be another recession at some point, but right now, it is nowhere in sight.
As the stock market has been going up since March 2009, some investors are finding their 60% stock and 40% bond portfolio is now 80% stocks. If 60/40 was the proper portfolio before, this investor is weighted too heavily in stocks today. Let’s say this investor wants to now reduce their stock allocation from 80% to 60%. Lorenz Financial recommends selling some stocks over a two-year period. This can be done at the rate of 1% per month for 20 months. If that is too much of a hassle, sell 5% of the stock holdings in four increments, six months apart. Just take things slow.
Recommended Action for Your Stock Portfolio
Lorenz Financial expects the bull market trend to remain intact at least into next year. While there is plenty of time for the forward economic scenario to change between now and next year, we regard the risk of a recession as minimal at this time. Two key pre-recession indicators continue to strongly suggest that the economy will enter 2019 on a growth track. These indicators are the Leading Economic Index (LEI) and the yield curve. Therefore, we recommend your stock market allocation should be fully invested in a low-cost, highly diversified, and tax-efficient manner at this time.
ESTATE PLANNING
There is currently chaos in multiple estates due to the deceased dying with no will. These include Michael Jackson, Prince, and now Aretha Franklin. Lorenz Financial does not provide estate planning services, but we broadly know what most adults need. See our list below.
The Six Legal Documents (Almost) Everyone Needs
Lorenz Financial has run into a number of households that do not have their estate planning complete. Below are the six documents everyone needs. For a married couple, that is 12 documents total. These documents should be obtained from an estate planning attorney licensed in your state.
THREE ESTATE DOCUMENTS
- Last Will – A legal document that defines who will inherit all property that is solely held in your name upon your death. A will also defines the primary and secondary designees for the executor of the estate, the investment advisor for any money given to children under 18, and the custodian of the children under 18. Wills do not avoid Probate Court. Wills are basically instructions to the probate judge.
- Revocable Living Trust– A revocable living trust is designed to avoid probate court when someone dies. “Revocable” means you can change any aspect of the trust as many times as you want prior to death. “Living” means it can instruct on how your assets and bills should be managed if you become unable to do so. Most importantly, upon your death, it allows the assets in the trust to pass directly to your heirs as defined in the trust without enduring the time, hassle, and costs of probate court. Court costs can often be 5% of the value of the total assets, plus lawyer fees. Even if probate court costs are low in your state, you will still want to set up a revocable living trust to avoid the annoyance and extended timeframe of the probate court. After setting up the trust, the trust must be funded or else it is worthless! Consult your attorney regarding the funding of your trust.
- Durable Power of Attorney– A durable power of attorney (POA) is an authorization that allows one person to represent another person in private affairs, business, or other legal matters. The person authorizing the other to act is the principal, grantor, or donor. The one authorized to act is the agent or attorney-in-fact. “Durable” means the agent is allowed to act even if the grantor is incapacitated. The POA terminates when the grantor dies or when the grantor revokes the POA in writing.
THREE MEDICAL DOCUMENTS
- Healthcare Power of Attorney – This document tells medical personnel who has the legal authority to make medical decisions on your behalf.
- Living Will – Also called a healthcare directive, this is a document that defines how you want to be medically treated in the event you’re incapacitated or terminally ill. A “Do Not Resuscitate”(DNR) order might be a part of a living will, or it might be a separate document. In most cases, a DNR must be signed by a doctor.
- HIPAA Waiver– This document defines with whom a doctor or hospital can share your medical information.
Please seek out a licensed estate planning attorney in your state to complete these documents for you and your spouse BEFORE a tragedy happens.
BOND MARKET
Commentary
Lorenz Financial is monitoring the real level of the federal funds rate by adjusting for the current inflation rate. When we subtract the 2% PCE core inflation rate from the federal funds rate, we see the real federal funds rate is close to zero – as it has been since early 2008. This increases the likelihood of additional rate increases in the short term.
The combination of higher short-term rates, as well as the ongoing quantitative tightening program, should support higher interest rates across the yield curve into 2019.
Federal Reserve
The Federal Reserve said at the end of their August 1 meeting, “the labor market has continued to strengthen, and economic activity has been rising at a strong rate.”
Quantitative tightening continues by the Fed, with $40B in U.S. Treasuries sold off each month during the third quarter. This increases to $50B per month in the fourth quarter and beyond. The Fed’s balance sheet has already reduced from its peak of $4.5T to $4.2T. With $600B rolling off the balance sheet in each of 2019 and 2020, we should see the Fed’s balance sheet around $3T in early 2021 if there is no recession.
The next Federal Open Market Committee (FOMC) meeting will be September 25 and 26. Lorenz Financial expects a 0.25% increase in the federal funds rate at this meeting. The new range is expected to be 2.00% to 2.25%.
U.S. Treasuries
In addition to the Treasury’s one-month and three-month T-bills, the Treasury will start to issue a two-month T-bill starting on October 16, 2018. The Treasury is also increasing the size of its near-term auctions. Two- to five-year notes will be increased by $3B each, and seven- to ten-year notes will be increased by $1B each. This additional revenue is needed to pay for the higher level of federal government spending.
Recommended Action for Your Bond Portfolio
Our bond market investments remain mostly unchanged. We are investing only in short-term, investment-grade bond funds; intermediate-term, investment-grade bond funds; short-term, high-yield bond funds; and high-grade money market accounts. The latter should yield approximately 2% annually.
We are not recommending any long-term bonds or long-term bond funds due to the current high interest-rate risk. Muni bond funds are not recommended at this time due to the risk of too many U.S. cities and states potentially going bankrupt due to unfunded pension obligations. 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 U.S. dollar, low yields, and the risk of bankruptcy.