Market Return in Election Years + Financial Market Update + 9.22.20

Market Return in Election Years + Financial Market Update + 9.22.20

FINANCIAL MARKET UPDATE 9.22.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

MARKET RETURN IN ELECTION YEARS

With the first Presidential debate one week away, the focus on the election is likely to intensify. Many investors are concerned about the potential impact on their portfolio, and the financial media knows exactly how to capitalize on this fear. There will be an endless wave of articles warning of grave risks, attempting to predict the future, and providing the exact way to position for it. The responsible stewardship of your life savings is not their objective. The goal of these articles is to attract eyeballs and generate advertising revenue. Be warned.

A few weeks ago, we discussed how the market has performed based on which political party was in power (Read the Article). Contrary to conventional wisdom, there is no discernable pattern between the two. This week we will view the same topic through a different lens. What if the true investment risk lies not in the election outcome, but instead resides within the uncertainty during the lead-up? This would explain investors’ common desire to refrain from investing in new capital or to lower portfolio risk ahead of time. Vanguard recently published some data that illustrates the efficacy of these strategies. The chart below shows the average return during election years versus the average in all others. With data going back to 1860, election years have returned 8.9% on average, exceeding the non-election year average of 8.1%. The implication here is that investors have historically paid a high price in terms of opportunity cost to sit on the sidelines and wait for the dust to settle.

If the volatility that investors must endure around elections to earn a reasonable return is much higher than usual, there would be some justification for de-risking. A second chart produced by Vanguard (below) takes a look at this. As you can see, the months before and after an election have actually been a little less volatile than the long-term norm. Despite the headlines, there is little evidence that election battles have a meaningful impact on the market.

Of course, just because returns have been high and volatility low on average around elections, does not mean it will be the case this time. As the first chart illustrates, there have been episodes with negative returns in the past, and clearly, 2020 is no stranger to high volatility. Still, with as anxious as many investors get about their portfolios around election time, it is surprising to see how benign these periods have been historically. Ultimately, there is almost always going to be an election or some other transitory event that people are fixated on. The key to investment success is being patient and focusing on the long-term. Stay diversified and tune out the noise.

WEEK IN REVIEW

  • Last Wednesday, the Federal Reserve announced its updated monetary policy stance, leaving its benchmark interest rate unchanged at 0-0.25% (as expected). In addition, the committee updated its economic projections for the coming year(s), expanding its forecast horizon through 2023. The median projection for the benchmark federal funds rate is unchanged at 0-0.25% through 2023, affirming the Fed’s previous indications that they will keep interest rates low for an extended period. The median forecast for 2020 GDP growth increased from -6.5% to -3.7%, although growth in subsequent years was revised lower. Inflation forecasts were increased, although inflation is not expected to achieve 2.0% until 2023. Finally, the forecast for unemployment was revised lower for 2020 and in subsequent years.
  • Data reported last week showed U.S. consumer spending slowed in August. Core retail sales, which exclude automobiles, gasoline, building materials, and food services, declined by 0.1% in August and were revised lower in July. According to CNBC, economists estimate that the reduction in extra unemployment benefits from $600 to $300 in July equated to a loss of income of $70 billion for the month, and may have weighed on spending.
  • Highlights for the remainder of this week include an assortment of Fed speakers, including multiple rounds of congressional testimony from Chairman Powell. Additionally, we will get an update on jobless claims Thursday, and durable goods orders data on Friday (which includes a proxy for business investment used in the calculation of GDP).

HOT READS

Markets

  • U.S. Consumer Spending Appears to Slow In August (CNBC)
  • Jobless Claims Were Lower than Expected, but Employment Growth is Still Sluggish (CNBC)
  • Head of Nikola, A G.M. Electric Truck Partner, Quits Amid Fraud Claims (NYT)

Investing

  • Some Investors Tried to Win by Losing Less. They Lost Anyway (Jason Zweig)
  • Negativity is Not an Investment Strategy (Ben Carlson)

Other

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

Market Return in Election Years + Financial Market Update + 9.22.20

Correction in Growth Stocks + Financial Market Update + 9.15.20

FINANCIAL MARKET UPDATE 9.15.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

CORRECTION IN GROWTH STOCKS

After a blistering summer rally, the high-flying growth stocks of the Nasdaq 100 hit a wall in early September. In just three trading days, the index saw its value drop by more than 10%, exceeding a threshold for what defines a “market correction.” Corrections are a healthy part of the normal ebb and flow of the stock market and help clear away some of the excesses that build up when the market runs too far too fast.

High-growth companies, including many firms in the technology sector, have led the rally following the steep sell-off earlier this year. Intuitively this makes sense. While the response to the coronavirus outbreak continues to wreak havoc on various industries, it has been a tailwind for others. This includes the technology that has enabled the shift to remote work. I don’t believe I had ever heard of Zoom prior to 2020, but even as I wrote this, I had to pause and hop on one of the many Zoom calls I have scheduled this week.

The strong stock performance of high-growth companies may have been justified early in the rally, given their relatively strong operating results. More recently, however, the gains seem to have gone too far. As more investors have piled in to chase high returns, prices have moved beyond reasonable levels. This has been exacerbated by the expanded use of options by both retail and institutional investors to make leveraged bets on continued gains. 

The chart below illustrates a composite of valuation ratios for large-cap growth companies relative to the U.S. stock market as a whole. The key takeaway is that while large-growth companies have enjoyed relatively good operating results, it is not enough to justify the sky-high prices investors must now pay to own them. This is evident by the fact that valuation ratios are rising, which is a consequence of the price gains outpacing the fundamentals. Simply put, prices are rising because investors are willing to pay more of a premium for growth than usual. When valuations become this stretched, it typically does not take much for prices to correct back to normal levels, which is what we have just witnessed.

Source: Morningstar Direct, data through 8/31/2020. The relative measure compares an equally weighted composite of P/E, P/B, P/S, and P/CF for the S&P 500 Growth index relative to the Russell 3000.

The opposite is currently true for value companies. These firms typically trade at a discount relative to the stock market as a whole, but that discount is currently significantly larger than normal. The discount effectively prices in the fact that some of these businesses were likely adversely affected by the pandemic. Even small improvements to the outlook for these companies could justify a rise in prices to move valuation ratios to more normal levels.

Source: Morningstar Direct, data through 8/31/2020. The relative measure compares an equally weighted composite of P/E, P/B, P/S, and P/CF for the S&P 500 Value index relative to the Russell 3000.

The valuation gap between growth and value stocks remains large and would require more than a 10% drop to normalize. This is particularly true given value stocks sold off in early September as well, just not as severely as growth. It’s possible the correction will signify a change in market leadership, but market imbalances can persist for extended periods. Value investors should be prepared for continued growth out-performance.

WEEK IN REVIEW

  • On Wednesday, the Federal Reserve will conclude its meeting of the Federal Open Market Committee (FOMC). The Fed is not expected to move rates from near zero. They will provide an updated “Dot Plot”, which illustrates the economic projections of the committee, as well as the expected future path of the Federal Funds rate. The market pays significant attention to the Dot Plot, particularly when investors anticipate a potential change in the policy rate (which is not currently the case). Finally, investors will look for details on how the Fed plans to implement its new “average inflation” policy framework, as well as any updates to the current bond buying program.   
  • Data released last Friday showed that inflation accelerated by a small amount in August, but remains below the Federal Reserve’s 2% target. The headline figure increased from 1.0% to 1.3% YoY, while the core CPI (which strips out the volatile food and energy components) increased from 1.6% to 1.7%. Prices for used automobiles were the largest contributor to the increase. As long as inflation remains low, the Federal Reserve has little reason to do anything to tighten monetary conditions.
  • Important events in the week ahead include the FOMC’s policy announcement Wednesday at 1 CT (followed by a post-meeting press conference on Yahoo Finance shortly after). Additionally, the August retail sales figure will be published Wednesday morning and updated jobless claims data on Thursday.

HOT READS

Markets

  • ‘Real’ Bond Yields Help Explain Surprising Market Moves (WSJ)
  • The Wildly Popular Trades Behind The Market’s Swoon and Surge (WSJ)

Investing

  • Are You an Investor or a Gambler? The Stock Market Knows (Zweig)
  • Republicans or Democrats: Who is Better for the Economy? (CFAi)

Other

  • You Have a Million Tabs Open. Here’s How to Manage Them (Wired)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Do you want to receive financial market updates in your inbox? Sign up here! 

ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

Market Return in Election Years + Financial Market Update + 9.22.20

The Election and Your Portfolio + Financial Market Update + 9.1.20

FINANCIAL MARKET UPDATE 9.1.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

THE ELECTION AND YOUR PORTFOLIO

With the election just months away, many investors are contemplating how the outcome might impact their investments. For many people, politics can elicit strong emotions. Passion, properly channeled, can lead to major achievements in many aspects of life. When it comes to investing, however, emotion often leads to poor choices and can be detrimental to investment performance. 

Whether or not one’s preferred party is in office can dramatically impact their overall outlook. This is especially true in the realm of investing, and it will lead a subset of investors to liquidate their portfolio in anticipation of their candidate(s) losing. The fact that this pattern repeats over each election cycle would suggest this behavior has been rewarded historically. However, the data suggests otherwise. The chart below illustrates the market performance during the various presidential terms going back to the 1920s. There is no apparent relationship between who controls the White House and how the market performs. Each party has seen negative returns, low returns, and high returns. 

While the President has the power to impact the financial market and the real economy, it is just one of many variables that exerts influence. Global trade, interest rates, inflation, the business cycle, economic conditions outside the U.S., market valuations, war, and pandemics can all significantly influence the trajectory of economic growth and asset prices.

The market hates uncertainty, and a potential shift to policies considered less favorable for businesses would likely generate volatility. Similar transitions have occurred many times throughout history. While there has been heartburn as change was initially digested, the market has hardly skipped a beat. Entrepreneurship and innovation have powered the U.S. market forward and will continue to do so. As the chart below illustrates, long-term investors have been rewarded for staying invested regardless of which party has held power. 

Over the next few months, the election is going to dominate the headlines. There will be an endless supply of people trying to predict the future and how to position for it. This is all noise. The best course of action is for investors to separate their politics from their portfolio and focus on their long-term plan. Don’t bet on a Republican win to achieve your financial goals, and don’t bet on the Democrats either. Bet on the millions of small business owners (including many of our readers) and corporate leaders to adapt to any environment and continue to grow. Your portfolio is invested in them, not a political party.

Nearly a century of market history suggests the market will likely be higher in November 2024 than it is today, regardless of who wins the election.

WEEK IN REVIEW

  • August was a strong month for the S&P 500. The index finished up 7.2%, the largest monthly gain since April, and the best August return since 1986. August has historically delivered the lowest return of any month on average.
  • In a speech last week, Fed Chair Jerome Powell laid the foundation for a new approach to achieving its dual mandate of maximum employment and stable inflation. The new approach will focus on targeting 2% inflation on average. Under this framework, periods of sub-2% inflation, similar to what we have been experiencing, would allow the Fed to subsequently tolerate a modest inflation overshoot in its pursuit of full employment.  
  • Economic data published this morning by the Institute of Supply Management (ISM) showed factory output increased in August at the fastest rate since November of 2018. The data showed that manufacturing firms continued to cut employment, however. Other economic data to look for this week include jobless claims and an update on the services sector on Thursday, and the jobs report on Friday.

HOT READS

Markets

  • Individual-Investor Boom Reshapes U.S. Stock Market (WSJ)
  • When the Magic Happens (Morgan Housel)
  • Tesla To Sell Up to $5 Billion in Stock Amid Its Incredible Rally (CNBC)

Investing

  • Warren Buffett and the $300,000 haircut (Zweig)
  • Warren Buffet, at 90, Still Has an Eye for a Bargain (WSJ)

Other

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Do you want to receive financial market updates in your inbox? Sign up here! 

ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

Market Return in Election Years + Financial Market Update + 9.22.20

Ignore the Dow + Financial Market Update + 8.25.20

FINANCIAL MARKET UPDATE 8.25.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

IGNORE THE DOW

Late yesterday it was announced that the Dow Jones Industrial Average (Dow) will be undergoing a major facelift. The update was prompted by Apple’s decision to undergo a 4-for-1 stock split, a move that would have materially altered its composition. As a result, the committee that oversees the index elected to make some adjustments to mitigate the impact. This includes dropping Exxon Mobil, Pfizer, and Raytheon technologies, and replacing them with Salesforce, Amgen, and Honeywell. Exxon Mobil had been in the Dow for 92 years. While this news is getting a lot of airtime in the financial media, and I just wasted a paragraph summarizing it, this is not important news.

While the Dow remains popular with many individual investors and is commonly quoted in the media, it is severely outdated and inferior to many other gauges for the U.S. stock market. For this reason, most professional investors focus their attention on indices that are more comprehensive and better designed, such as the Russell 3000 or the CRSP US Total Market Indices. One drawback here is that these indices are not commonly quoted in the media. The S&P 500 offers the next best, albeit imperfect option.      

The Dow was created in 1896 by the editor of the Wall Street Journal and co-founder of Dow Jones & Company, Charles Dow, and his partner Edward Jones. It is the second longest-running market index in the United States, trailing only the Dow Jones Transportation average, which began in 1884. Compared to today, the makeup of the economy was dramatically different in the late 1800s, with railroads and other transport companies comprising roughly 50% of the stock market at one point, hence the development of the transportation index first.

The Dow is vastly inferior to modern indices for a variety of reasons. The most glaring criticism is the method it uses to weight the constituents. Broadly speaking, the two most common approaches weight companies based on price or market capitalization (market cap).

  • Price Weighting: Company weights are determined by the price of an individual share.
  • Market Cap Weighting: Company weights are based on the actual market value, calculated as the share price times the total number of shares outstanding.

The table below provides a hypothetical example to illustrate how the results differ between the two methods. Since Company A has a much larger share price ($90), it gets a correspondingly larger weight than Company B in the price index (90% vs. 10%). Company B, however, has significantly more shares outstanding, and its total market value (10 x 3,600 = $36,000) is approximately double Company A’s. Clearly, the price index is not accurately reflecting the relative size of the two firms.

 

In the late 1800s, weighting by share price was a simple and straightforward way to calculate an index. The advent of computers, however, made the market cap methodology feasible. Not only does market cap do a better job of reflecting the true relative size of index constituents, but it also handles corporate actions like stock splits better. While Apple’s 4-for-1 split has no impact on cap-weighted indices like the S&P 500, it has a profound impact on the Dow. Apple is currently the largest weighted company in the Dow by far but will fall to the 17th position overnight once the announced index changes are made.

Another common criticism of the Dow relates to its high concentration. The U.S. stock market is comprised of thousands of companies. The best representation of how the market is performing would be an index that tracks all of them. Meanwhile, the Dow only tracks thirty firms. Although it is diversified across sectors (excluding transports and utilities), it still omits a meaningful amount of the market, which can lead to dramatic performance differences over time. This critique can (rightfully) be applied to the S&P 500 as well, however, it covers more than 80% of the market and is the most comprehensive gauge among those commonly quoted in the media.   

In today’s world, where crunching numbers and sharing information are extremely easy, there is simply no reason for a back-of-the-napkin approach like the one used by the Dow to garner so much attention. Investors are better served by ignoring the Dow and focusing on other more comprehensive gauges of the market. 

WEEK IN REVIEW

  • The S&P 500 has recently joined the Nasdaq in pushing to new all-time highs in recent days and closed above 3,400 for the first time yesterday.
  • Investor sentiment was buoyed early this week by the FDA’s emergency use authorization of convalescent plasma for the treatment of COVID-19. Positive developments related to the pandemic have consistently boosted stocks higher, particularly those in the hardest-hit segments of the market.
  • Last week initial jobless claims moved above 1 million after briefly declining below that level. Later this week, look for updates on durable/capital goods (Wednesday), initial jobless claims and a revised estimate of Q2 GDP (Thursday), and inflation and a potentially important speech by Fed Chair Powell in Jackson Hole (Friday).

HOT READS

Markets

  • Powell Set to Deliver ‘Profoundly Consequential’ Speech, Changing how the Fed Views Inflation (CNBC)
  • Coronavirus Lifts Government Debt to WWII Levels-Cutting It Won’t Be Easy (WSJ)
  • Home Prices Show Signs of Recovery, Rising 4.3% in June, According to Case-Shiller Index (CNBC)

Investing

  • The Cost of Anticipating Corrections (Swedroe)
  • This Fund Is Up 7,298% in 10 Years. You Don’t Want It. (Zweig)
  • Reasons Not to Be Cheerful (James Montier)

Other

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Do you want to receive financial market updates in your inbox? Sign up here! 

ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

Market Return in Election Years + Financial Market Update + 9.22.20

Bond Renaissance Over? Expect Muted Returns the Next Decade + Financial Market Update + 8.18.20

FINANCIAL MARKET UPDATE 8.18.2020

GUEST AUTHOR: NICK HALL

STORY OF THE WEEK

BOND RENAISSANCE OVER? EXPECT MUTED RETURNS THIS NEXT DECADE

Despite all the craziness in the equity markets in 2020, bonds have largely done their job of reducing overall portfolio volatility. Most sectors of the bond market have actually done very well and have aided in portfolio returns year-to-date.

The advisors in our firm meet quarterly as an investment committee. Besides portfolio risk management and fund selection due diligence, one of the most crucial discussions that stem from this meeting is the future expected rate of returns. Future expected returns play a big role in the individual retirement cash flow planning scenarios we discuss with clients. Based on the current climate and metrics used for gauging expected returns- a significant part of the return equation that could really serve as an anchor this next decade is bonds.

Since the beginning of 1979, the Bloomberg Barclays Aggregate Bond Index has returned 7.36%. That is not a typo, over 7% returns the past 40+ years! Most investors would take that return year over year with a fraction of the risk that comes with the stock market. The past thirty to forty years have been the best bull market for bonds in our country’s history as interest rates dropped from the mid-teens highs of the 1980s to today’s lows. As a quick reminder, bond prices are inverse of interest rates, and as rates plummeted over the last forty years, bond prices increased- making the higher-yielding older bonds more valuable and expensive than newer, lower rate bonds.

Bringing this back to recent history and looking at the Federal Reserve’s monetary policy can provide us a good road map on future fixed income returns. During the Great Recession, the Fed lowered rates to zero where they stayed until December 2015. From December 2015 through December 2018, the Federal Reserve voted to increase the Federal Funds rate nine times until the rate reached the range of 2.25-2.50% in December 2018. Other rates and yields followed directionally during this climb to the fall of 2018. By Halloween 2018, the 10-year Treasury Yield had reached 3.22% (an 8-year high), and 30-year mortgage rates were near 5%. However, if we look closer at total returns for the aggregate bond index from 2015-2018, we realize rising rates were at the detriment of bond total returns. The Vanguard Total Bond ETF (BND), that tracks the Bloomberg Barclays Aggregate Bond Index, had an average return of only 1.62% over those four years.  While the climb for higher rates hurt short-term returns, it is positive thing long-term for bondholders, many of which include retirees, because they will get paid more in the long-term on the money they are lending to government or corporations.

What has happened since the fall of 2018 to change this narrative? First, Q4 of 2018 saw the first 20% drop in the stock market since 2011 as fears mounted over trade wars/tariffs, a slowdown in China, and a housing slowdown. Even as the stock market bounced back in Q1 of 2019, trade wars concerns and fears of the end of a historic bull market quickly mounted. Investors sold stocks and fled to safer, more conservative bonds. In July 2019, the Federal Reserve agreed to reverse course and cut rates for the first time since 2008. They cut rates two more times in 2019, and as we entered 2020, there were further expectations of gradual rate cuts over the coming years. Shortly after the calendar flipped to 2020, the COVID-19 pandemic spread worldwide while simultaneously disrupting global economies. As a response to the COVID pandemic, the Federal Reserve took drastic measures and made two emergency rate cuts down to zero over two weeks in March 2020.

The downward pressure over of rates over the last 22 months, coupled with stock market concerns and increased demand for bonds has led to a short-term boon for bond investors. In fact, the aggregate bond index returned almost 9% in 2019, which was the best year for bond returns since 2002. Through August 17th, the Bloomberg Barclays Aggregate Bond index is again up almost 7% on the year. As I mentioned at the outset, bonds have been additive to portfolio return this year despite all of the stock market volatility. However, we are now sitting near all-time lows for the 10-year treasury and with the Federal Reserve rate at zero. The 10-year treasury is currently yielding approximately 0.69%. A blended bond portfolio, like that of BND, holds some lower credit, higher-yielding investment-grade corporate bonds and municipal backed securities. Thus, our expectation of total bond returns over the next five to ten years is somewhere in the 1.25-1.5% range. If interest rates stay low, bondholders will be subject to the low cost for borrowers in the form of lower dividends. When interest rates eventually increase, it will be a painful climb upwards (see 2015-2018) as bond prices drop. Armed with this information, we need to set investor’s expectations that average annual total bond returns certainly won’t be what they were the past 40 years or even what they have been over the past ten years given today’s historically low interest rate environment.

WEEK IN REVIEW

  • Data released last week showed retail sales recovered to pre-pandemic levels in July, as the 1.2% month-over-month increase marked the third consecutive rise. Consumer spending accounts for roughly 2/3rds of overall economic activity, with retail sales comprising a large portion. There are some concerns that the ending of the $600/month enhanced unemployment benefits could be a headwind in the coming months, despite an executive order to replace about half of the benefit. In other positive economic news, industrial production, which measures the output from manufacturers, utilities, and miners, also increased for the third consecutive month. Finally, the initial jobless claims figure fell below 1 million for the first time since mid-March.
  • As of August 7th, 90% of S&P 500 companies have reported results for the second quarter. 83% of companies that have reported have beat expectations. The blended earnings decline, comprised of the results from companies that have reported and the estimates for those that have yet to report, is -33.8% for the quarter. The initial estimates for the earnings decline was -44.1% as of June 30th. The improved results of reported earnings versus initial estimates has been a tailwind for the stock market.
  • Later this week, we will get the minutes from the recent FOMC meeting (Wednesday), initial and continuing jobless claims (Thursday), and the Markit service and manufacturing PMIs (Friday).

HOT READS

Markets

  • U.S. Stocks are Valued More than Almost Half of Global Economic Output (Sentiment Trader)
  • Another Roaring Twenties May Be Ahead (Ed Yardeni)
  • Eight High Frequency Indicators for the Economy (Calculated Risk)

Investing

  • Which Investments Benefit From a Weaker Dollar (AWOCS)
  • 500,004 Reasons I’m Not Buying Gold (ETF.com)

Other

  • Looking to Refinance? Those Rock-Bottom Mortgage Rates Aren’t for You (WSJ)
  • The NBA Playoffs, Brought to You by Kawhi Leonard (WSJ)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

Do you want to receive financial market updates in your inbox? Sign up here! 

ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

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Market Return in Election Years + Financial Market Update + 9.22.20

Breaking Down the GDP Report + Financial Market Update + 8.4.20

FINANCIAL MARKET UPDATE 8.4.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

BREAKING DOWN THE GDP REPORT

Economic data dominated headlines last week following the report of Gross Domestic Product (GDP) for the second quarter. The figure, which showed economic activity declined by an annualized 32.9%, was reported as the worst on record. While the number is undoubtedly awful, it is likely somewhat overstating the depth of decline, and there are emerging signs that activity has already begun to rebound. Before we go there, let’s begin with a little bit of background. 

 

What is GDP?

GDP measures the total value of all goods and services produced in a country within a specific period of time. The data provides an assessment of the overall size and health of the economy and is the gold standard for measuring growth. GDP is calculated by the Bureau of Economic Analysis (BEA) and is published quarterly.

There are four major components used to calculate GDP:  GDP = C + I + G + (X-M)

Consumer spending typically comprises about 2/3rds of the figure, which is why consumer sentiment data is so widely followed. Given the U.S. has consistently run a trade deficit over the years (imports have exceeded exports), the trade balance component has generally been a drag on GDP.

Q2 Data

The 32.9% annualized decline in GDP during the second quarter is by far the steepest drop since record-keeping began in the 1940s. For comparison purposes, the first quarter of 1958 saw the next largest decline of 10.0%. The worst data print during the Great Recession was the fourth quarter of 2008, which saw an 8.4% decline. Last week’s report follows an annualized decline of 5.0% Q1. Two consecutive quarters of negative GDP is traditionally what signals the economy has entered into a recession. The decline in economic activity and the spike in unemployment since February was so dramatic. However, authorities did not wait for the GDP data to declare that a recession had begun.

The fall in Q2 came from a collapse in consumer spending and private investment caused by lockdowns and social distancing measures. Increases in federal government spending offset declines at the state and local levels, while the level of imports declined faster than exports, each of which made small positive contributions to the figure. 

Source: BEA

Where We Go From Here

As I mentioned at the start, the GDP decline has likely been overstated, arising from the fact that the data has been annualized. Annualizing assumes that the next three quarters will be identical to the last. This is most likely an unreasonable assumption, as much of the country was in full lockdown mode for a meaningful portion of the quarter. The non-annualized GDP figure reflects a much lower 9.5% decline in economic activity.

A surge in COVID-19 cases that began in early June has caused some states to roll back some easing of restrictions. Recently, there has been evidence the overall spread has begun to slow, and the level of economic activity has continued to be much higher than in prior months. Many economists are anticipating a return to growth in Q3. The Federal Reserve Bank of Atlanta publishes a widely followed real-time estimate of GDP (GDPNow), which is currently forecasting annualized Q3 GDP at 19.6%. Again, annualizing the data will overstate the degree of change. Some portion of the growth likely represents pent-up demand from when the economy was locked down, so the initial pace of recovery will likely moderate. Still, the return to growth would be a welcomed occurrence and would make this recession one of the shortest (albeit deepest) on record.

WEEK IN REVIEW

  • Last week the Federal Reserve announced the decision to hold interest rates steady at 0.00-0.25% following the conclusion of its Federal Open Market Committee (FOMC) meeting (as expected). It also reiterated its intention to maintain its bond purchase and other lending programs it had enacted to restore proper market functioning. At the post-meeting press conference, Fed Chair Jerome Powell reiterated the view that “the path of the economy will depend significantly on the course of the virus.”
  • The Institute for Supply Management (ISM) published its manufacturing index at the beginning of the week, which climbed to a 15-month high of 54.2%. The index generally reflects the rate of change in activity and not the actual level. As a result, it appears the manufacturing sector is improving but remains at a much lower overall level than it did before the pandemic. Later this week, we will get ISM’s non-manufacturing index (Wednesday), initial & continuing jobless claims (Thursday), and headlining the week of economic data will be the jobs report (Friday).
  • 63% of the companies in the S&P 500 have reported earnings for the second quarter. If you blend the earnings growth rate of the companies that have already reported, with the estimates from the companies that have yet to report, Q2 earnings growth is currently -35.7%. This represents an improvement over the -44.1% expected at the beginning of the quarter. Reports published last Thursday showed Apple, Facebook, Amazon, and Alphabet all beat earnings estimates, which contributed to the improved blended earnings growth rate.

HOT READS

Markets

  • Fed Holds Rates Steady, Says Economic Growth is ‘Well Below’ Pre-Pandemic Level (CNBC)
  • Covid Supercharges Federal Reserve as Backup Lender to the World (WSJ)
  • High Frequency Indicators for the Economy (Calculated Risk)

Investing

  • Does a Mutual Fund’s Past Performance Predict Its Future? (Yale Insights)
  • Big Tech Faithful Shouldn’t Ignore Antitrust Risk (Bloomberg)

Other

  • How Tech is Packing Empty Stadiums with (Fake) Raucous Crowds (Protocol)
  • Covid-19 Prompted Purdue University to Shut Its MBA Program. More Closures Are Expected. (WSJ)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY