September 2019 Market Review

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With competing economic data, where should investors turn?

Oil shocks, impeachment, and Brexit – Oh My!

Key Takeaways

  • U.S. stock and bond markets closed the 3rd quarter with an impressive – though volatile – year-to-date return. The S&P 500 index ended September up nearly 19%, the best 3-quarter return since 1997, while the Barclays Aggregate Bond index posted an outstanding return near 8%.
  • Economic data remained mixed. The U.S. Consumer Confidence index fell by -9.1%, much more than expected, but unemployment fell to 3.5%, the lowest in 50 years.
  • The House of Representatives initiated an impeachment investigation of President Trump after a ‘whistleblower’ leaked information about the President asking Ukrainian officials to investigate Democratic candidate Joe Biden’s son.
  • Drone strikes on Saudi Arabian oil installations shut down 50% of Saudi oil production, about 5% of world production, briefly sending oil prices off the rails and adding to recession fears.
  • Prime Minister Boris Johnson was deemed to have acted illegally by shutting down the U.K. Parliament, putting pressure on him to come to a Brexit resolution with the European Union.
  • Conclusion: The U.S. economy remains on track for a good year. Despite the markets’ willingness to shrug off trade wars and geopolitical uncertainty, significant challenges are still out there. Investors should prepare  for renewed market turbulence as these issues resolve themselves over the coming months.

Stock and bond markets rebound from August’s slump

The 3rd quarter was quite a roller coaster ride! Gold and other ‘safe’ assets were the go-to market segments for the quarter. Gold led the way with a return of +4.26%[1], despite a slip in late September. U.S. bonds took second place, edging out U.S. stocks with a return of 2.34% versus 1.75%. International stocks were the top performers in September at +3.7%, but continued to lag the U.S. for the quarter at -0.79%. Emerging markets equities were in second place for the month at +1.91%, but are far behind for the year and quarter, losing -4.75% between July 1st and September 30th.

Market returns 7/1/2019 – 10/4/2019

https://stockcharts.com/h-perf/ui

The financial markets continued to react strongly to economic news and geopolitical events, though the magnitude of the swings began to subside. This moderation is a bit surprising given the unexpected -9% drop in Consumer Confidence and the Purchasing Manufacturers Index falling to its lowest level since June 2009. But investor fatigue is bound to set in sooner or later, and current events just seem to build on a base with which investors have become wearily familiar.

Source: https://ycharts.com/indicators/us_pmi

The economy created only 136,000 new jobs in September – certainly nothing to brag about, but good enough this late in the expansion. At the same time, the unemployment rate fell to 3.5% – the lowest in half a century – and the overall employment ratio increased to 61%, the highest since December 2008. Apparently, the U.S. job market is alive and well…at least for the time being.

Despite competing political and economic pressures, U.S. and developed international stock markets are on track for a very strong year. As of October 7, the S&P 500 was up more than 19%, gold was up over 16%, and the Europe, Australasia, and Far East index was up nearly 12%. But be wary of another 4th quarter slump like we saw in 2018! Given mixed economic data, the impeachment inquiry of President Trump, and continuing trade tensions, any of these could derail the markets – at least temporarily – between now and December 31st.

Market returns 1/1/2019 – 10/4/2019

https://stockcharts.com/h-perf/ui

One of the less-reported casualties in the U.S.-China trade war is the agricultural sector. Inflation-adjusted prices for corn, wheat, and soybeans have been declining for decades, largely due to increased productivity and reduced global population growth. Add trade tariffs and the wettest 12 months on record[3], and farmers are facing a ‘perfect storm’ of negative events. Smaller farms are going out of business, and the number of farms in the U.S. is heading below 2 million, the lowest in nearly a century.

But despite the significant challenges facing the agriculture and manufacturing sectors, the U.S. economy is holding steady. Personal income and consumer spending rose in August for the second month in a row. Retail sales were good, and housing showed signs of renewed activity.

 

As reported by the Wall Street Journal on September 25, U.S. home-price growth is slowing and mortgage rates are historically low at around 4%[4]. With such low interest rates, home price affordability remains within reach as indicated by the sharp drop in the Case-Shiller Home Price Index in 2019, shown on the chart above.

Forecasters expect housing to contribute slightly to GDP for the first time since 2017 as home sales and construction increased in August.

With so much going on in the world, it’s hard to know which direction to turn! For a straightforward summary of the likely impact of these competing economic factors on global growth, we refer you to the graphic below prepared by The Conference Board (publisher of the Leading Economic Indicator index.)

The Conference Board economic outlook

Bottom line: the U.S. economy is on track for solid growth in 2019, slowing somewhat thereafter. A recession is not in the forecast for the next 12 months, though demographic factors point to slower growth worldwide in the coming years.

Given the myriad challenges facing the global economy right now, negative surprises are definitely a possibility as we navigate the final quarter of 2019. Investors may just have to close their eyes, hold on tight to a prudent investment plan, and ride out the inevitable turbulence in the coming months.

Marcia Clark, CFA, MBA

Senior Research Analyst, Warren Street Wealth Advisors

 

 

 

 

 

DISCLOSURES

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications.

Form ADV available upon request 714-876-6200

[1] Performance represented by ETFs designed to track various market segments: SPY (S&P 500), AGG (Barclay’s Aggregate Bond index), EEM (emerging markets equity), EFA (developed international equity), GLD (gold prices)

[2] Performance represented by ETFs designed to track various market segments: SPY (S&P 500), AGG (Barclay’s Aggregate Bond index), EEM (emerging markets equity), EFA (developed international equity), GLD (gold prices)

[3] https://www.wsj.com/graphics/us-farmers-miserable-year/?mod=article_inline&mod=hp_lead_pos5

[4] https://blogs.wsj.com/economics/2019/09/25/newsletter-housings-maybe-rebound-chinas-decoupling-warning-and-consumers-cloudy-crystal-ball/?guid=BL-REB-39607&dsk=y

August market commentary

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In an uncertain market environment, which is better?

The U.S. stock market feasts on recession fears before regaining its risk appetite in late August

Key Takeaways

  • President Trump added, then delayed, another tariff on Chinese goods, exacerbating trade tensions and concerns about the strength of the global economy. As talks with China resume, Britain’s new prime minister attempts to achieve a ‘hard Brexit’, and the Eurozone PMI index falls into contraction territory.
  • The U.S. economic menu included something for everyone: for the pessimist, softer than expected gain in overall jobs with only 130,000 payroll growth in August. For the optimist, the broader measure of civilian employment surged by 590,000. Manufacturing remains a worry as contraction in that sector continues. Despite the generally stable U.S. economy, the Fed cut rates by -0.25% in July and is expected to cut again in September.
  • Conclusion: Tariffs and political uncertainty are depressing an already delicate global appetite for risk. The U.S. is buffered by its large domestic market and expanding trade with alternative suppliers, but isn’t immune to a global slowdown. Lower interest rates may provide a brief energy boost, but won’t develop core strength in business investment. With no political solution in sight, prudent investors should diversify exposure to provide a steady diet of modest returns while avoiding the binge/purge cycle of ‘chasing yield’.

Stocks are near record levels, but investors are uneasy

4Q2019 repeats 4Q2018?

As reported in the Wall Street Journal on September 9, despite a buoyant stock market so far this month, some investors fear the market may repeat the ‘binge and purge’ cycle experienced in 2018.

Looking as far back as 1928, September is historically the worst month of the year.[1] Given that most of the tensions which led to the market tumble last year are still present – trade tensions, global manufacturing slowdown, falling growth of corporate profits, and political uncertainty at home and abroad – concern may be warranted. Combine these headwinds with diminishing marginal returns from accommodative monetary policy, and we might finally be nearing the end of the longest economic expansion in recent memory. Not that we’re calling for a recession! Just that the growth engines of the global economy are beginning to run out of fuel.

[1] https://www.wsj.com/articles/stocks-are-back-near-records-but-memories-of-2018-leave-investors-uneasy-11568021402

Bonds have been a dietary staple during stock market volatility in recent quarters.

Despite the S&P 500 posting a year-to-date return of nearly 20% as of August 31st, bonds have actually outpaced stocks for the trailing 12-months. The severe tumble of the stock market in late 2018 and again in late July/early August gobbled up more losses than the 2019 recovery has been able to replenish. This despite continuing strength in the U.S. economy and corporate earnings generally surprising on the upside of – admittedly cautious – analyst expectations.

The Fed’s rate cut at the end of July sparked an increase in recession fears, though economic data remains modestly positive.

10-year Treasury yield barely above inflation

Decreasing short-term interest rates are unlikely to spark business appetites for borrowing or lending. While 2% short-term rates are great for speculators, they aren’t that much more enticing than 2.25% or 2.50% interest rates for strategic business investments. In fact, 10-year Treasury bond yields dropped so low in September that they provided no more than 0.25% returns above inflation. While marginal borrowers may consume more debt at these rates, long-term investors will need to look beyond the safest assets for a risk/reward balance that preserves purchasing power while promoting healthy growth.

Manufacturing businesses suffer from a restrictive diet of trade tariffs and global uncertainty.

While the U.S. economy overall remains on solid footing, trade-related businesses are hungry.

Housing starts stabilize

Jobless claims remain low

Retail sales rebound

Housing starts are stable, retail sales have rebounded, and initial claims for unemployment are the lowest in more than a decade…

 

 

…but U.S. manufacturers are in desperate need of an economic shot of Red Bull.

Rising global trade tensions in the wake of U.S. tariffs on steel, aluminum, and lumber imports, as well as those targeted specifically at China, are directly impacting manufacturing activity. According to the National Association for Business Economics (NABE)[1], 76% of goods-producing sector panelists and 42% of TUIC (transportation, utilities, information, communications) panelists reported negative net tariff impacts at their companies.

This impact is illustrated by the significant drop in durable goods orders over the past year or so.

Durable goods orders fall sharply

[2] https://nabe.com/NABE/Surveys/Business_Conditions_Surveys/July_2019_Business_Conditions_Survey_Summary.aspx

[Preceding charts source www.macrotrends.net]

Increasing tariffs are not just eating the lunch of U.S. manufacturing companies. Global exporters are suffering greatly from decreased trade around the world. If we look back at the recovery from the Great Recession, emerging economies such as China are credited with helping the developed world get back on its feet. China in particular built roads, airports, and housing developments with abandon, which boosted earnings for global manufacturing companies, particularly steel and machinery.

But the Chinese economy has had its fill of infrastructure spending, reducing its appetite for imported goods going forward. Combined with the trade war between China and the U.S., exporters have lost a major customer. Eurozone manufacturers have already fallen into ‘contraction’ territory (PMI below 50), and the rest of the world isn’t much better.[3] And Fed Chairman Powell, if you’re listening, lower interest rates won’t have any effect on this trend! No matter how low rates go, businesses won’t go back to the buffet table when demand for their products is already satisfied.

[3] https://www.wsj.com/articles/chinas-power-to-boost-global-economy-is-fading-11564738205?mod=article_inline

Slowdown in China depresses global manufacturing

In an uncertain global economic environment with a reactionary U.S. stock market, diversification is even more important.

Barring major disruptions in trade negotiations, a disorderly ‘Brexit’, or increases in geopolitical unrest, the U.S. stock and bond markets could continue on their upward path for the rest of the year.

That being said, the chance of one of these elements going wrong is significant. Investors should continue to make healthy investment decisions to navigate this uncertain period. The best way to do this is to diversify.

Source: www.portfoliovizualizer.com

A balanced menu of stocks, bonds, and alternative asset classes such as natural resources can provide welcome reduction in volatility while still supporting the pursuit of gains suitable for most investors’ appetites. Which isn’t to say even the most well-diversified investors won’t experience some indigestion along the way! But putting your investment eggs in several market baskets can avoid catastrophic losses and help you achieve a healthy balance of risk and return over the long term.

Marcia Clark, CFA, MBA

Senior Research Analyst, Warren Street Wealth Advisors

 

 

 

 

 

 

DISCLOSURES

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications.

Form ADV available upon request 714-876-6200

Did the Fed make a mistake? – “A Few Minutes with Marcia”

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Welcome back to A Few Minutes with Marcia. My name is Marcia Clark, senior research analyst at Warren Street Wealth Advisors.

Today we’re going to spend a few minutes considering the pros and cons of the Federal Reserve Open Market Committee holding short-term interest rates steady at its June meeting. Most of my comments today are based on the FOMC announcement published on June 19, the press conference with Chairman Jerome Powell shortly thereafter, and remarks by Federal Reserve Governor Lael Brainard on June 21st.

Watch:

 

On June 19, the Federal Reserve Open Market Committee announced its decision to keep short-term interest rates unchanged at 2.25%-2.5%. Did they make a mistake?

To answer this question, let’s put ourselves in the shoes of the Fed and attempt to base our opinion on the available data. The Fed should reduce rates if they see the economy struggling. Is that what they see?

During a speech in Cincinnati on June 21st, Fed Governor Lael Brainard stated his assessment that the most likely path for the economy remains solid. He noted strength in consumer spending and consumer confidence, as well as unemployment at a 50-year low.

He did note a few areas of concern: cautious business investment due to policy uncertainty, slow growth overseas, and muted inflation.

  • Mr. Brainard said: “The downside risks, if they materialize, could weigh on economic activity. Basic principles of risk management in a low neutral rate environment with compressed conventional policy space would argue for softening the expected path of policy when risks shift to the downside.” But what does he mean by ‘compressed conventional policy space’?

The Fed has limited room to maneuver because interest rates are already low, and inflation and employment have not responded to changes in interest rates as predictably as they have in the past. 

  • On the plus side, this means the labor market can strengthen a lot without an acceleration in inflation
  • On the other hand, this low sensitivity along with already low interest rates gives the Fed less ability to buffer the economy in a downturn

 

If the Fed doesn’t get their interest rate call right, the economy could begin to spiral too far up or too far down.

Let’s take a deeper look at why low interest rates present a challenge for the Fed.

  • In the past, the Federal Reserve has cut interest rates 4 to 5 percentage points in order to combat past recessions
  • The chart on slide 6 shows the current Fed Funds rate sitting at less than half where it was before the last two recessions. 
  • Clearly there is less room to run if a recession hits

 

The chart also shows GDP beginning to stabilize at the end of 2016. With GDP on a more steady path, back in 2017 the Fed started raising short-term interest rates toward a more normal level in order to have some ‘dry powder’ for the next recession.

How did we get to this delicate balance point?

In December 2018, the Fed said more rate hikes were appropriate given the strengthening economy. The stock market reacted badly as at the same time trade talks with China were going nowhere and portions of the Treasury yield curve were inverted. Recession fears were on everyone’s mind.

In March 2019, Federal Reserve officials reassure markets that they will be “patient” with increasing short-term interest rates. To quote the FOMC statement after the March meeting: “the case for raising rates has weakened…” Notice that they didn’t say the case for cutting rates has strengthened.

And in June, the FOMC held interest rates steady and stated that the current level of interest rates is consistent with its mission to promote full employment and price stability. In its post-meeting statement, the committee said that the timing and size of future adjustments will be based on economic conditions relative to these two objectives. 

After the announcement, both stocks and bonds reacted positively to the decision, with the stock market indexes touching new highs before falling back a bit at the end of the week. 

Commentators speculated that the markets reacted well because a rate cut could be imminent. Equally likely, however, is that the markets reacted to the lack of a rate hike and prospects that a recession is not around the corner. 

During a press conference after the announcement, Fed chairman Jerome Powell responded to a question by saying that being independent of political pressure or market sentiment has served the country well and would do so in the future. He stated that the FOMC will react to data and trends that are sustainable rather than individual data points that can be volatile. 

But despite all the evidence, as we approach the end of June an astonishing 100% of futures investors are betting on a rate cut in July. These investors are wrong. 

Why am I so sure they won’t cut rates when commentators and the futures market clearly think differently?

You may have heard the expression ‘pushing on a string’. What this means is that applying force to something with no rigidity won’t have any impact – the string absorbs the force and the force doesn’t go any further. This is the current situation with monetary policy.

Imagine pushing a sofa across your carpeted living room versus pushing a mattress across the same room.

Once the feet of the sofa get out of the dent they made in the carpet, the sofa will move fairly easily. That’s because the sofa is rigid – when you apply force at one end, the sofa moves away from the force.

But a mattress is much more resistant to shifting. That’s because much of the force you apply is absorbed by the cushioning already in the mattress. The mattress will often bend before it will move. The force doesn’t go anywhere or accomplish anything.

The current U.S. economy is like the mattress in this example. The U.S. economy has plenty of available capital and interest rates are already low. Reducing the Fed Funds target from 2.375% to 2.00% is unlikely to accomplish much other than encouraging unwise borrowing and ultimately sparking inflation.

Yes, bad things can happen to our economy and the Fed needs to guard against a recession. But a recession overseas is much more likely than in the U.S., and no U.S. recession has ever been caused by a recession overseas. Dropping interest rates to ease market concerns or satisfy political sentiment is not the Fed’s mandate and would be counterproductive.

Barring some catastrophic political event or natural disaster, the U.S. economy is unlikely to falter between now and mid-July. 

Recognizing the Fed’s dual mandate of stable prices and full employment are both being met at the current level of short-term interest rates, right now the downside risk of lowering rates outweighs the potential stimulus benefit. The FOMC should keep the Fed Funds rate steady when they meet in July.

This has been ‘A Few Minutes with Marcia’. I hope you are a bit clearer on how to assess the likelihood of Fed policy decisions going forward. As always, comments and questions are welcome!

Sources:

 

Marcia Clark, CFA, MBA
Senior Research Analyst
Warren Street Wealth Advisors

Warren Street Wealth Advisors, a Registered Investment Advisor. The information contained herein does not involve the rendering of personalized investment advice but is limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the strategies or options presented. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss. 

 

DISCLOSURES

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications.

Form ADV available upon request 714-876-6200

The bulls are back! But for how long?

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Key Takeaways

  • The U.S. economy just exceeded the record for the longest business cycle expansion since economists started recording expansions in the 1930s (120 months plus 1 day)
  • Global trade tensions are impacting manufacturing sectors all around the world; only the U.S. and France show continued expansion, with Germany falling the most
  • Despite these concerns, June 2019 was among the strongest months for the U.S. stock market since 1955, driven largely by the FOMC decision to keep interest rates low and expectations of moderating trade tensions between the U.S. and China
  • An astonishing 100% of futures markets participants expect the Fed to cut the Federal Funds rate between 0.25% and 0.50% in July. Conventional wisdom states that when 100% of market participants expect something, it’s time for rational investors to exit.
  • Conclusion: Forecasts for multiple cuts in the Federal Funds rate are overdone; investors should be prepared for the stock market to react badly if expected rate cuts don’t materialize in July.

When the FOMC announced they would not raise the Federal Funds rate in June, global stock markets cheered.

Despite continuing uncertainty about trade tariffs, the decision not to raise rates was a relief to investors. Stock prices in both Europe and the U.S. jumped immediately after the announcement and held their gains through the rest of the week. Treasury bond prices rallied as well, bringing the 10-year interest rate below 2% for the first time since November 2016.

Source: finance.yahoo.com

This enthusiasm may be warranted as the U.S. economy has reached the longest expansion since economists started recording expansions in the 1930s (120 months plus 1 day), edging past the expansion of 1991 to 2001.

But the markets seem a bit schizophrenic lately in their response to economic data.

Longest expansion since 1930s

After their meeting in mid-June, Federal Reserve officials indicated that monetary policy can remain accomodative because concerns about a weakening economy had increased.

Here is the schizophrenic part: If the economy is indeed slowing, shouldn’t the stock market be cautious since corporate profits are expected to slow? But despite a few bad days and weeks from time to time, the U.S. stock market has hit new highs in 2019. If the Fed becomes more confident about the economy and raises interest rates slightly, this should signal stronger future corporate profits and boost the stock market. But instead of cheers, the prospect of the Fed continuing to ‘normalize’ short-term interest rates has been met with stock market tumbles.

This fearful reaction might be based on historical precedents which are no longer relevant. Some past expansions were indeed derailed by the Fed increasing rates too much. But the last 3 recessions in the U.S. were not sparked by interest rate increases but by market excesses: the Dot Com boom and bust in 1999-2000 and the housing price bubble in 2007-2008 being prime examples.

To better gauge when and if the economic expansion has run its course, investors would be wise to worry less about the Federal Funds rate and more about asset values, business activity, and the strength of labor markets.

According to Dr. David Kelly, chief global strategist for J.P. Morgan Asset Management, the four key areas to watch in regard to ‘expansion killers’ are home building, business fixed investment, motor vehicle sales, and change in inventories.

Dr. David Kelly’s ‘expansion killers’

Recessions since the late 90s have been associated less with interest rates and more with booms and busts in at least one of these areas. Since none of these factors are in ‘boom’ territory, it’s difficult to imagine a ‘bust’ scenario around the corner. As Dr. Kelly said, it’s hard to hurt yourself when jumping out a basement window.

The only leading indicator sitting on the second floor – rather than the basement – is the level of U.S. stock prices relative to earnings. As reported by Ned Davis Research, S&P 500 valuations in June were higher than average, but not by much. Whether you look at current earnings or forward earnings projections, the stock market seems to be fairly valued.

U.S. stock market valuation seems fair

In any case, the Fed may have less ability to influence the economy than people think.

These days inflation seems more responsive to changes in global dynamics such as oil prices rather than domestic economic factors. Changing the Federal Funds rate isn’t likely to make much difference in the current economic environment.

Low wage growth keeps inflation under control

Despite record low unemployment, wage growth has remained subdued helping keep inflation low as participants have begun returning to the job market after being sidelined during the ‘Great Recession’ of 2008-2009.

Range-bound oil prices are also putting downward pressure on inflation. OPEC has been trying to limit oil production for 2 years now, with mixed results. Their goal is to balance excess supply with less demand given the slowing Chinese economy, tariffs, and other political concerns. Despite these efforts, oil supplies are plentiful and prices remain restrained.

U.S. oil production offsets OPEC cuts

Has the Fed done too much? Or perhaps too little? When looking at the Federal Funds rate from a historical perspective, the FOMC has been extraordinarily cautious in its pace of increasing interest rates. Fed governors could certainly make a mistake, but it seems like their slow and steady pace is a wise approach for the foreseeable future. There’s no urgent need to raise rates, and limited value in lowering rates.

FOMC has been cautious ‘normalizing’ interest rates

The primary risk to the global economy, particularly the manufacturing sector, isn’t interest rates but rather trade tensions. The U.S. and France are the only developed economies with manufacturing sectors still in expansion territory. Overseas, Germany’s manufacturing sector has fallen the most as much of its manufactured goods have traditionally been exported to the U.S. and other countries.

With most of the developed world struggling to stay in positive territory, global demand and supply dynamics are likely to keep U.S. inflation near or below the Fed’s 2% target indefinitely.

Global manufacturing feels the bite of tariffs

Despite the modestly positive economic landscape, an astonishing 100% of Eurodollar futures participants expect the Fed to cut the rates between 0.25% and 0.50% in July.

Since the Fed’s decision in June to keep interest rates the same, futures market participants began enthusiastically betting on not just one 0.25% cut, but two cuts in the Federal Funds rate when the FOMC meets in July. Conventional wisdom states that when 100% of market participants expect something, it’s time for rational investors to exit.

After the first flurry of press reports forecasting a rate cut in July, more Fed officials have been speaking publicly about their base case economic scenario being steady, not requiring a rate cut. In recent days futures markets have slowly begun migrating away from projecting two rate cuts in July to only one, but even one cut isn’t justified by the data…at least not yet.

Futures expectations for July rate cuts

If we look forward to the end of the year, according to the CME Group ‘Countdown to FOMC’ as of July 1st over 13% of futures market participants think the Fed Funds rate will end the year between 2% and 2.25% (0.25% below the current level); another 13% believe the rate will be between 1.25% and 1.50% (1% below the current level!); and the median expectation is split with about 35% forecasting a Fed Funds rate between 1.5% and 1.75% (0.75% below the current level) and another 35% forecasting the Fed Funds rate to be between 1.75% and 2.0% by December (0.50% below the current level).

Barring a steep recession in the near term, expectations for multiple cuts in the Federal Funds rate are misguided. As my colleague at WSWA put it, the Fed is stuck in the unenviable position of a parent in the supermarket with a fractious child demanding candy before dinner. The right thing is to say No, but it’s difficult for both the parent (the Fed) and bystanders not to give in to the pressure.

Futures forecast for rate hikes by December

 

With all this uncertainty, where can investors find good opportunities?

The answer is: In the global equity markets, particularly in Europe. The U.S. market should be fine going forward, but the best returns may have already come and gone. Though European economies are having a tough time right now, the European stock markets have been punished perhaps more than is warranted. In fact, the price of European stocks as of May 31st is less than 13 times compared to the U.S. stock market at close to 16 times earnings.

International stock valuation cheaper than U.S.

The way ahead in Europe is not going to be smooth, but long-term investors should consider dipping into international markets where stock valuations are more attractive. Overseas countries are generally behind the U.S. in their business cycles and have more growth to come.

Conclusion: Investors and the Fed should stay the course. Sometimes the best decision is to do nothing…for now.

Yes, the global economy is struggling right now. Corporations and governments have been issuing too much debt. Trade tensions and uncertainty make it difficult for businesses to develop long-term growth strategies. Political tensions across Europe and the U.K. are adding uncertainty to global economies.

Despite these concerns, the Fed should not lower interest rates. In fact, there is a case to be made to raise rates to balance outcomes between savers and speculators, plus keep some dry powder for the next recession.

Long-term investors should consider international assets. This is not the environment to make big bets either in or out of the financial markets. Instead, investors should stay engaged in the markets and be selective about segments likely to provide a reasonable risk/return profile over the remaining business cycle. With government bond yields extremely low and U.S. stock prices fully valued, carefully selected international securities may be the right choice for patient investors able to handle some bumps along the way.

Marcia Clark, CFA
Senior Research Analyst

DISCLOSURES

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications.

Form ADV available upon request 714-876-6200

March 2019 Market Commentary

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Key Takeaways

    • The rally in U.S. stocks slowed in March but still posted the best 1st quarter in recent memory at 13.65%, though stock markets remain volatile as investors seem to overreact to fears of the Fed increasing interest rates too much or not increasing rates at all
    • A slightly better-than-expected jobs report for March helped calm fears about mixed economic data in the U.S., supporting the Fed’s decision to keep short-term interest rates low for the foreseeable future
    • The OECD lowered its forecast for European GDP growth to a paltry 1.0% in 2019 and 1.2% in 2020; German government bonds fell into negative territory after the ECB reported weak manufacturing data
    • Overall, improved labor conditions, lower headline inflation, and accommodative monetary policy should help support real income growth and household spending in most developed countries

 

  • Conclusion: Recent market swings seem driven more by fear than by fundamentals. Economic data isn’t great, but the data doesn’t support a forecast for a global recession; U.S. markets are likely to hang on to gains until or unless weakness in the economy becomes more clear.

 

 

Is the U.S. economy getting better? Or getting worse?

The S&P 500 had its best 1st quarter return in recent memory, yet the Federal Reserve Bank kept interest rates low to avoid derailing the economy. Which of these forward-looking indicators is correct? To answer this question, let’s start at the beginning. You may have learned in school that GDP – the primary measure of economic strength – is simply the value of all goods and services sold in a country over a given period of time. In essence, GDP represents the value of business transactions. These transactions flow into company financial statements and impact the ability of these companies to pay dividends or launch new ventures. This increased cash flow is recognized by investors, who become willing to pay more for shares of those businesses in the stock market, pushing stock prices up. If the economy is up, stock prices are up too.

Easy, right? All the dominoes line up and we understand how the market works…or maybe not?

Here is the conundrum: stock prices are a ‘leading economic indicator’ because investors buy today expecting gains in the future. Interest rates are also leading indicators because investors need to forecast future interest rates – which typically move up and down with economic activity – before they’re willing to tie up their money for 10 or 20 years. Stock and bond prices don’t usually go up together.

Source: https://www.pimco.com/en-us/resources/education/everything-you-need-to-know-about-bonds

If interest rates go up, prices of existing fixed-rate bonds go down in order to compete with new bonds issued with higher coupon (interest) rates. But rising interest rates usually indicate more demand for funds, which is often associated with a strong economy, which means more profits, and consequently higher stock prices.

The upshot of all this is when stock prices go up, bond prices are usually flat or negative. Conversely, when stock prices go down, bond prices are usually positive as investors sell volatile stocks and seek safer assets such as government bonds.

Source: https://stockcharts.com/h-perf/ui

As you can see from the chart above, bond prices as represented by the long-term Treasury ETF (ticker ‘TLT’ – blue line) usually go up when stock prices go down (represented by the Dow Jones Industrial Average – black line), and vice versa. This effect was particularly dramatic during the 4th quarter of 2018.

Despite the strong start for stocks in 2019, if you look back 6-months from October to March, bonds have been among the best performing asset classes. Bonds may not be sexy, but they sure are welcome when markets get rough! But wait – look at the red box in February and March. Bond and stock prices are moving together. Why??

The charts below from the Bureau of Economic Analysis may hold some of the answers. In a nutshell, the problem is Change. And I don’t mean the kind of change you find in your sofa cushions…

Chart 1: The U.S. economy is growing, but slower than in recent quarters.

 

Consumer spending takes a breath after spiking in April

Chart 2: Disposable income is increasing, but consumer spending is down.

Chart 3: Companies are adding value to GDP, but at a slower pace than previously.

The economic data is okay, but clearly slowing from the strong levels of 2017-2018. Does ‘slowing’ economic activity mean a recession is around the corner? I don’t think so, and many commentators are coming around to this view. What’s really moving the market, then? In addition to economic fundamentals, the stock market seems to be overreacting to the possibility of interest rates going up…or going down. Does being afraid of both situations make any sense? Probably not.

If the Fed increases rates too aggressively, they could indeed stall the economy. But we should take comfort in the persistent ‘data dependent’ stance of the Fed. They have no intention of being aggressive with interest rate hikes, so the stock market should probably find something else to worry about. In fact, institutional investors seem to agree that short-term rates are going nowhere any time soon. Federal Funds futures contracts are predicting the Fed will decrease rates by the end of 2019, though the Fed’s own ‘dot plot’ shows a possibility of one rate increase by the end of the year.

Source: https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html

Source: https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20190320.pdf

The Fed is also cautious about raising short-term rates too quickly and causing the Treasury yield curve to become ‘inverted’. An inverted yield curve is one where short-term interest rates are higher than longer term rates. This isn’t normal! Investors and lenders usually require higher rates to lock up their money for a longer period of time. An inverted curve is usually driven by…here’s that word again…Change.

The yield curve can invert under three basic scenarios:

 

  • The Fed is aggressively increasing short-term interest rates to cool down an overheated economy

 

  • Investors are demanding less return for longer maturities because they believe inflation, and consequently future interest rates, will be lower than they are currently

 

  • Differing supply and demand pressures on the short and long portions of the yield curve, sometimes driven by interest rate differentials between the U.S. and other developed countries

 

 

 

An inverted yield curve has preceded many recessions in the past few decades, which is why it makes people uncomfortable. But the inversion has happened as much as 2 years before the recession, so I’m not sure that the curve is actually predicting anything. It’s more helpful to analyze the economic situation driving the curve shape, rather than drawing conclusions from the curve alone. You might take comfort in knowing that post-inversion recessions have only happened when the 10-year Treasury yield was at least 0.50% below the Fed Funds rate, which we’re nowhere near. Right now my money is on Option #3 – a supply demand imbalance, not an imminent recession. Nonetheless, the current Treasury curve is slightly inverted between the 1 year and 5 year maturities and the Fed doesn’t want it to get worse and spook investors.

Source: Morningstar.com

It doesn’t make much sense for investors to be afraid of interest rates going up and also afraid of interest rates going down. But that seems to be the case at the moment and is a key driver of recent volatility in the U.S. stock market. Let’s be ‘data dependent’ for a minute and draw our own conclusions based on what we can see in the global economic landscape:

  1. The Fed is being cautious about raising or lowering interest rates because economic data doesn’t point strongly either up or down and they don’t want to spook the financial markets
  2. Though corporate earnings forecasts are lower than 2018, the majority of S&P 500 companies reporting slower earnings projections for the 1st quarter of 2019 have experienced positive stock price movement; S&P 500 gains year-to-date have been felt broadly across many sectors
  3. U.S. manufacturing output slipped to its lowest level in 2 years, despite trade tensions between the U.S. and China moderating somewhat rather than getting worse
  4. Challenges persist overseas, particularly in Europe, as trade tariffs hit European and Asian businesses harder than the U.S.; factory output in the Eurozone fell in March at the fastest pace in 6 years
  5. Manufacturing data in China, the second largest economy in the world, was stronger than expected in March; the Chinese economy is expected to slow to a still robust 6% GDP growth in 2019 and beyond
  6. European markets are stabilizing as the U.K. Parliament seems to be making progress identifying a viable ‘Brexit’ strategy; economic disaster in Europe due to stalled trade with Britain seems unlikely
  7. Trade tariffs aside, improved labor conditions, lower headline inflation, and accommodative monetary policy should help support real income growth and household spending in most developed countries
  8. Emerging economies are avoiding much of the global slowdown as many smaller countries benefit from strong capital investment, improving income growth, and economic and political reforms in recent years

What conclusions can we draw from all this data?

The economic data is certainly mixed, but most indicators point to slower growth in 2019, not a recession. From what we can see today, global economies, and consequently financial markets, should stay in modestly positive territory for the near term. We can sleep well at night knowing the ship is headed in the right direction…for now.

 

ASSET CLASS and SECTOR RETURNS as of MARCH 2019

Source: Morningstar Direct

Source: S&P Dow Jones Indices

Marcia Clark, CFA, MBA
Senior Research Analyst
Warren Street Wealth Advisors

Warren Street Wealth Advisors, a Registered Investment Advisor. The information contained herein does not involve the rendering of personalized investment advice but is limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the strategies or options presented. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss. 

DISCLOSURES

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

 

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications.

Form ADV available upon request 714-876-6200

 

Does PG&E’s Recent Bankruptcy Announcement Scare You?

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Here Are The Things All Employees Should Be Aware of Regardless of Where You Work

By Justin D. Rucci, CFP® 

As many of you are likely aware, PG&E recently announced a bankruptcy filing as the result of roughly $30B in potential liabilities stemming from recent California wildfires. Regardless of whether or not you work for a public utility, it is only natural to have questions around what to expect or what precautions you should be taking with your own money. With that said, below are some items you will want to remain cognizant of should more wildfires occur or things change.

Things to Think About:

401k

While your 401(k) account is technically “tied” to your employer, your contributions and vested matching contributions will not be at creditor risk should your company go bankrupt. As part of the Employee Retirement Income Security Act of 1974(ERISA), your 401(k) assets are required by law to be held in trust separate from the company. This means the assets are not commingled with the company’s general operating funds and are not accessible to the company should they need operating capital or funds to pay creditors. Your investments within the 401(k) are always subject to your own investment risk, so be sure to contact Warren Street Wealth Advisors if you would like guidance on the plan’s investment options.

Pension

Pension plans are another common concern for those worried about their company potentially filing for bankruptcy. Luckily ERISA comes into play here as well. As part of the enacting of ERISA, a government agency titled the Pension Benefit & Guaranty Corp.(PBGC) was formed. This agency is designed to step in to pay benefits should a private pension plan fall to bankruptcy. This agency will step in to pay receipt of your pension benefits at normal retirement age, annuity benefits to your survivors, disability benefits, and most early retirement benefits. The PBGC will not however pay for severance packages, vacation pay, or similar benefits. While benefits are guaranteed by the PBGC, they do enforce limits on what is covered by the agency, meaning it is possible that you would not necessarily receive your entire benefit. Maximum benefit guarantees can vary, but more information is available on the PBGC website here.

Retirement

How should you time your retirement if you are worried about your company going bankrupt? The short answer is, you probably shouldn’t dictate your retirement decision based solely on the possibility of a corporate bankruptcy. While the possibility of benefits being cut and severance package offerings are very real for companies that are struggling financially, often times it makes sense to take an individualized approach to analyze the situation before making a rash decision on retirement. Pension plans may change from a defined benefit annuity stream to a cash balance “lump sum” in some cases, but this does not necessarily mean it is time to retire. I would recommend speaking to an advisor should you have questions about your specific company and situation to determine what the best course of action may be for you.

What Should I Do?

For those interested in learning more about retirement and would like to meet with professional advisors, Warren Street Wealth Advisors hosts many events throughout the year. You can view our upcoming events here.

If you have any questions, contact info@warrenstreetwealth.com or call 714-876-6200. We are well versed in interpreting company benefits and are happy to talk through any of your questions or concerns.

Justin D. Rucci, CFP®
Wealth Advisor
Warren Street Wealth Advisors

 

 

 

Justin is an Investment Advisor Representative of Warren Street Wealth Advisors, a Registered Investment Advisor. The information contained herein does not involve the rendering of personalized investment advice but is limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the strategies or options presented.

Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance, strategy, and results of your portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. Nothing in this commentary is a solicitation to buy, or sell, any securities, or an attempt to furnish personal investment advice. We may hold securities referenced in the blog and due to the static nature of the content, those securities held may change over time and trades may be contrary to outdated posts.

 

Sources

https://www.bankrate.com/retirement/your-pension-when-the-unexpected-happens/

https://money.usnews.com/money/blogs/on-retirement/2010/12/14/what-happens-to-my-pension-if-my-company-goes-bankrupt-

What is a Roth Conversion?

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What is a Roth Conversion?

According to Investopedia, “a Roth IRA conversion is a reportable movement of assets from a Traditional IRA, SEP or SIMPLE IRA to a Roth IRA, which is a taxable event. A Roth conversion can be advantageous for individuals with large traditional IRA accounts who expect their future tax bills to stay at the same level or grow at the time they plan to start withdrawing from their tax-advantaged account, as a Roth IRA allows for tax-free withdrawals of qualified distributions.”

To simplify this down, you are taking assets from a qualified account, such as the traditional IRA,  paying the income taxes owed on the amount now, and moving them into a Roth IRA to capitalize on the tax-free income on eligible withdrawals.

Why would someone do this?

If someone feels that their tax liability is going to increase in the future, this provides a way for tax diversification. For example, if you are in a low tax bracket currently and have a large sum of your assets in qualified accounts, then it may make sense to convert the funds assuming you have the cash on hand to cover the tax liability.

Taking advantage of your low tax basis now (maybe even specific to the most recent tax reform) could allow you to control your RMDs (required minimum distributions) in the future or allow you to leave money more efficiently to your heirs, especially if your income tax rate is lower than theirs.

Who would be someone that would want to do this?

There are a couple different scenarios that this strategy might be useful in.

One is a retiree who is going to have no earned income and has plenty of assets for a successful retirement. If their asset base is large enough to not worry about income, chances are they may run into Required Minimum Distributions in the future. To control this, they could convert money now and limit their tax exposure during the RMD years. Additionally, if they plan to leave money to their heirs, this is an opportunity to leave it for them income tax-free.

A second scenario might include someone who is not in retirement, but perhaps they had a lower than normal income year, has a long time horizon until retirement, and has qualified assets they would rather have in a Roth. In our “younger than retirement age” scenario, their financial plan might dictate they would retire prior to the 59.5 age mark. This conversion would allow them to tap into their basis before 59.5.

In all instances, if someone has qualified assets, a lower than normal current tax environment, and the cash to complete the conversion, then it is something to be considered for financial planning purposes.

Additionally, there are some nuanced rules regarding how long someone must wait to access these funds known as the “5-year rule”. You can learn more about the finer details around that issue here: https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

How does one convert their traditional IRA funds to Roth?

This can be a tricky process since timelines and amounts might need to be tracked for the “5-year rule”, so we recommend speaking with your personal financial planner and/or accountant to make sure that this might be a good fit for you and your plan.

Overall, the Roth conversion can be a good strategy assuming that all the important variables line up in regards to tax rates, timing, and cash on hand. However, a Roth conversion should be considered on a case-by-case basis and may not be right for everyone. With it being a tricky strategy to execute, make sure you consult your financial advisor or account for a smooth process.

Cary Warren Facer, Founding Partner

Warren Street Wealth Advisors

 

Warren Street Wealth Advisors, a Registered Investment Advisor. The information contained herein does not involve the rendering of personalized investment advice but is limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the strategies or options presented. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss. Warren Street Wealth Advisors are not Certified Public Accountants and all tax-related matters should be vetted and acted on with your personal tax counsel.

 

Word on the Street – November 27th – December 1st

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Word on the Street – November 27th – December 1st

Another brief conversation with our CIO on current events in the investing world…

A sit down with Blake Street, CFA, CFP® to discuss some current events in the news, their impact on investors, and his sentiment on some issues. Enjoy…

Trade War talks are still present as people were worried about the G20 meeting. Since our last conversation, where do you think we are now with the trade talks?

Blake Street: Specific to the US and China, much remains to be seen. At this point, we are still on the light end of threatened tariffs with escalation due here soon without further intervention. In recent days, the President has new motivation to come up with some type of remedy to re-instill confidence in the markets. One way would be to calm US & China trade tensions and get global growth back on track. It remains to be seen if this is the case. As we have seen in the recent past, sometimes these summits result in a lot of talk and no action. The G20 Summit resulted in a “truce” or “ceasefire” of sorts between the US & China, however, very little clarity has been provided and an arrest of the CFO of Huawei, China’s largest tech company, this morning (12/6/2018) could further inflame tensions.

General Motors seems to have suffered greatly due to the tariffs, among other things. Do you think that this is going to be a reoccurring theme for some US companies, or is this just a casualty of war?

B.S.: I don’t know if you can say they suffered greatly, but they are doing what every company should do which is look out for their long-term interests. They have spotted changes in their own market landscape that require a change in where they produce their products and what products they produce for consumers. Tariffs have certainly hurt their bottom line by increasing certain input costs and while this seems obvious in hindsight, a lot of industries from automotive manufacturers to agricultural producers have been harmed by trade tensions and tariffs.

Oil prices are down again as well. How with this impact both consumers at the pump and investors? What do you think the long-term trend will be?

B.S.: Consumers during the holiday season will benefit by keeping more money in their pocket. However, falling crude prices can also come with other adverse impacts such as slowing economies and weak investment markets. Historically, 30% declines in crude oil prices have correlated strongly to short-term bear markets, not always a recession.

Personally, I think the most recent selloff is overdone, and we will return to higher oil prices in the not too distant future. Case and point, I don’t think that demand has dropped off in a meaningful way, and we have not seen the type of supply buildups reminiscent of 2015, the last time we saw oil prices collapse.

On Wednesday (11/28/2018), Jerome Powell, Chair of the Federal Reserve, came out and said that the Fed Funds rate is approaching neutral. This news was a stark contrast to his October statements. What does this mean for the market as we approach 2019?

B.S.: Investors and markets alike were appeased to hear that we may be due for fewer rate hikes than initially priced in. Foreign markets have also been dealing with adverse effects of a strengthening US dollar and rising US interest rates. Markets overseas breathed a sigh of relief to hear of a potentially more accommodative Fed policy.

In my mind, an even bigger question mark is how the Fed continues to handle the unwinding of its balance sheet in the coming years. I’m also slightly concerned with President Trump’s recent politicization of the Fed. At the end of the day, Fed Chair Jerome Powell has a job to do, and it is not solely to provide octane to investment markets at the President’s request. I expect the Fed to remain focused on their traditional mandate and to shirk Presidential pressures.

 

Warren Street Wealth Advisors, a Registered Investment Advisor. The information contained herein does not involve the rendering of personalized investment advice but is limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the strategies or options presented. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss. 

 

Case Study: Start Retirement on Vacation

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Case Study – Start Retirement on Vacation

Learn how we helped a client retire early, without penalty, move out-of-state, and get their desired income level by constructing a strong financial plan.

When most people think of working with a financial advisor for retirement, people think about investment management strategies. Having someone whom they could trust and feel confident in handling their money. Believe us, having trust and confidence in someone to handle your money correctly is a big piece of the puzzle when choosing an advisor.

However, a good financial advisor brings more to the table than their investment strategy. They should bring some financial planning knowledge that can help you retire smoothly and utilize as much of your retirement benefits as possible, and that is exactly what we want to share in this case study.

We worked with a client who planned on retiring towards the end of the year. They had done a great job saving, had plenty of assets to retire, and they were counting down the days to their December retirement date.

It was hard to not get wrapped up in their excitement because it is such an exhilarating time, but we wanted to make sure we had done all the due diligence on their benefits package. During our research, we learned how their vacation time worked which gave our client an incredible start to
retirement.

At this particular job, vacation time was reset as of the first of the year, so on January 1st, our client earned 6 weeks of paid vacation time. If you retire with vacation days left over, then you will get paid based off of how much of that time you “accrued”. For example, if you worked 6 months out of the year, then you would be able to get one-half of the unused vacation time paid out.

With our client planning on retiring so close to the new year, we advised them to delay their retirement a couple weeks, take vacation time the first 6 weeks of the new year, and be able to enjoy the full value of the benefit. The client even gets to collect a couple of paychecks to start their retirement.

By doing a bit of digging, we were able to get them more benefit than they had believed available and a great start to retirement. You want an advisor who is competent when it comes to building an investment strategy, but you also want to make sure your advisor is looking into every avenue possible to get you the benefits you have earned.

It would have been easy to tell the client to go ahead and retire, but it’s not about doing what is easy for the client.

It is about doing what is right and in the client’s best interest.

 

Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance, strategy, and results of your portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. Nothing in this commentary is a solicitation to buy, or sell, any securities, or an attempt to furnish personal investment advice. We may hold securities referenced in the blog and due to the static nature of the content, those securities held may change over time and trades may be contrary to outdated posts.

 

Word on the Street – A Conversation with Marcia Clark, CFA, MBA

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Word on the Street – A Conversation with Marcia Clark, CFA, MBA

A sit down with our Senior Research Analyst to discuss the US market, international markets, and how we are approaching both for investors.

For this Word on the Street, I sat down with Marcia Clark to discuss a recent report that stated leading economic indicators in the US are positive. Marcia and I discussed what this report means for investors and how it relates to our stance at Warren Street.

Enjoy.

Yesterday (October 18th), Blake shared a report that talked about long-term economic indicators looking good in the US. However, we have heard a lot from Blake on investing overseas in international and emerging markets. If the US looks so good, then why are we doing this?

M.C.: Even though indicators [in the US] are strong right now, we are still in an established economy, and it’s not possible for a huge economy like ours to grow as quickly as a smaller and more dynamic one. Smaller economies tend to grow faster than developed economies because they have to build out infrastructure to support new businesses. This infrastructure improves productivity which in turn drives economic growth. Since 2000, emerging economies have grown about twice as fast as developed economies.

How long will this period of US strength continue, and how long will we have to wait for emerging markets to have another boom?

M.C.: The US is currently experiencing one of the longest expansions in our history. While we’re grateful for the stable growth, we know this can’t go on forever. It’s extremely difficult to know when the end is coming or how bad it’s going to be, so what do we do? We hope for the best but prepare for the worst. To make an analogy – most of us don’t expect a house fire, but we still carry insurance. In the investment business, it’s wise to look over all markets to find the best opportunities and spread out the economic risk. 

When we spoke about the report that Blake shared, you said, “when the US gets sick, the world sneezes.” If the US is not sick at the moment, why does the rest of the world seem to be dragging this year?

M.C.: When we say the US isn’t sick, how are we measuring that? Most people look at the S&P 500 and say the US is doing great compared to global averages, but if we take out the huge technology companies such as Google, Amazon, and Netflix, the US market isn’t that much further ahead. Many other countries experienced a “Great Recession” fallout in 2008-2009 far worse than the US, leaving them behind the US on the economic recovery timeline, particularly in regards to unemployment. Add to that the continuing struggle of European countries to integrate thousands of refugees from wars and conflicts in the Middle East and you can see why Europe and its neighbors are having a tougher time than the US.

Some people say that emerging markets are not a great value right now. If that is true, then why are we continuing to add to our position with them?

M.C.  The US is largely insulated from many global challenges, but at the same time, the US is so well developed that there aren’t a ton of market-changing innovation opportunities here either. So, we look overseas. The first thing to understand about emerging market economies is that they are not a homogenous group. For example, you wouldn’t compare emerging economies in peripheral Europe to those in Africa or South America. When we look to add exposure in a diverse sector like EM, we investigate active asset managers with a track record of identifying the best risk-reward trade-off in that broad landscape.

So what you are saying is, when we talk about adding emerging market exposure, we are not getting all of the emerging market economies. What does Warren Street look at for their emerging market exposure?

M.C.: We aren’t investing directly in these countries, so we don’t have a country-by-country economic forecast. However, the fund managers we use do this full-time. Some even send members of their investment teams to these emerging countries to understand the political landscape, the sentiment of the population, and the vibrancy of the economy. Our job is to vet these managers thoroughly, check their track record across different economic cycles, and review their current country allocation against our thoughts on world conditions. From there, we then choose the best manager for the job.

Taking a step back to a previous question, what happens when the US does finally get sick? What happens to world economies in that landscape? Similar to your quote, I have heard “when the US gets sick, the world gets the flu.”

M.C.: It is true that the US impact on other countries is stronger than their impact on us, but the US economy is fairly insulated because we buy and sell so much within our own borders. In times when the US is struggling, other nations step up their trading with each other and muddle through until the US economy bounces back. As we talked about earlier, there are plenty of differences between the economic environment in the US and elsewhere – developed countries have done better than us plenty of times in the past. Remember that less developed countries are even less correlated with the US than developed nations. So when the US is sick, oftentimes the best place to look is smaller nations that are building their own economies in their own regions.

Taking a look back at the US economy, if the outlook is good, then why don’t we add more to the US stock market?

M.C.: Our job at Warren Street Wealth is to keep you safe and help you grow your assets. Even the most successful investors don’t have a crystal ball. They don’t get it right every time, so diversification is the only “free lunch” – we would be foolish not to take advantage of it.

The US is only about 40% of the world market. If we only invested in the US, we are closing ourselves off to an additional 60% of opportunities available to us. That just seems silly. Good stuff is happening all around the world, so let’s reach out and find it.

What do you say to the investor that only believes in the US stock market?

M.C.: For investors with a very long time horizon without the need to draw on their funds unexpectedly, the US stock market might be your only investment. But most of us don’t have the luxury of leaving our money in the market for 40 years and weathering all the storms that come our way. As fiduciaries of your assets, we have an obligation to protect your assets and help you achieve your long-term financial goals. We may not capture 100% of the upside, but we are confident that we are going to keep you from experiencing 100% of the bad times.

Anything else you would like to share?

M.C.: The world is a very big place, and sometimes we don’t know what exciting things are happening on the opposite side of the planet. Being open-minded about where you send your capital could unlock amazing things in other places.

Lastly, there is a fantastic set of information on the global economy that can be found at the IMF’s website: Real GDP by Country

Cary Warren Facer
Founding Partner
Warren Street Wealth Advisors

Warren Street Wealth Advisors, a Registered Investment Advisor. The information contained herein does not involve the rendering of personalized investment advice but is limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the strategies or options presented. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss.