Financial Market Update + 2.18.2020

Financial Market Update + 2.18.2020

FINANCIAL MARKET UPDATE 2.18.2020

STORY OF THE WEEK

THE DOLLAR IS RISING. IS THAT GOOD OR BAD?

The U.S. dollar has been appreciating relative to other currencies, and it is nearing the highest levels since 2017. Currency movements have both direct and indirect impacts on investors. Whether dollar strength helps or hurts is a matter of perspective.

Source: Koyfin.com

For a U.S.-based investor that has diversified their portfolio abroad, dollar strength can be a headwind. An international stock fund, for example, will take investor dollars and convert them into non-U.S. currencies to then invest in foreign stocks. The performance for this type of fund is therefore based on:

  1. The return of the underlying stock(s)
  2. The return of the currency

To say a foreign currency has weakened relative to the dollar, is to say it now purchases fewer dollars. When the international stock fund converts the foreign currencies back, fewer dollars translates as a negative return. The reverse is true when the dollar weakens. When the stronger foreign currency converts back to more dollars, the return impact is positive.   

A less direct consequence can be seen within the performance of individual companies. Domestic companies that export goods and services abroad can be hurt by a stronger dollar. As the dollar appreciates, U.S. exports become more expensive in the global market, which hurts demand and/or makes alternatives from other countries more attractive. This negatively impacts the exporter’s bottom line, and potentially their stock price as well. The reverse is true for importers, who benefit as the stronger dollar lowers their input costs.

Understanding the direct and indirect impact of dollar strength on a portfolio is not always straight forward. What happens if a U.S.-based investor invests in the stock market of another country that is a heavy exporter? On one hand, there is a negative return on the currency, as it converts back into fewer dollars. On the other hand, the exporters may benefit as their products have become cheaper in the global market place. The two factors offset to a degree, but it’s not easy to estimate how much.

Fortunately, it is not imperative to have a complete accounting of how currency movements have impacted past returns, or how things will play out in the future. Large movements in the dollar are very difficult to predict, but they tend to ‘mean revert’ (return to normal) in the long-term. This means the positive and negative impacts on investor portfolios generally wash out over time. For a diversified investor, dollar strength (or weakness) need not be feared.

WEEK IN REVIEW

  • As of last Friday, 77% of the companies in the S&P 500 have reported Q4 earnings. Blending the earnings growth rate of companies that have already reported with the estimates of companies that have yet to report, Q4 earnings are projected to be +0.9%, vs the initial expectation of -1.7%. With U.S. stocks valuations stretched, companies will need to grow the earnings to justify further/sustainable market gains.
  • The Bureau of Labor Statistics (BLS) published updated inflation data last week. The Consumer Price Index (CPI) increased at a 2.5% YoY clip, the fastest rate since October of 2018. Price gains were led by rising rents. The “core” CPI figure, which strips out the volatile food and energy components increased 2.3%, which has remained unchanged for the last four months.
  • Other data published last week showed that retail sales grew modestly in January (in line with expectations), while industrial production, which measures utilities, mining and manufacturing activity, declined for the fourth time in five months. The decline is being attributed to warmer weather reducing utility demand, and Boeing’s 737 Max issues lowering manufacturing.

HOT READS

Markets

  • ‘Dean of Valuation’ says Tesla would need VW-like sales and Apple-like margins to justify stock (CNBC)
  • U.S. Consumer Spending Picks Up, While Manufacturing Declines (WSJ)
  • Japan’s Economy Shrinks 6.3% as Sales-Tax Increase Cools Consumption (WSJ)

Investing

  • LAnd of the Undead (Prof Galloway) Netflix may not survive the streaming wars
  • Some Lessons From 92 Years of Market Return Data (AWOCS)
  • Crash Course (Humble Dollar) 30 years after their market collapse, Japanese stocks remain 40% off their 1989 peak

Other

  • How George Steinbrenner and the Harlem Globetrotters Changed the NBA Forever (WSJ)
  • The Perils of “Survivorship Bias” (Scientific American)
  • They Documented the Coronavirus Crisis in Wuhan. Then They Vanished (NYT)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: Treasury.gov

Source: Treasury.gov

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

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

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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

Financial Market Update + 2.18.2020

Financial Market Update + 2.11.2020

FINANCIAL MARKET UPDATE 2.11.2020

STORY OF THE WEEK

oil enters a bear market

It has been a rough start to the year for oil, which has entered a bear market after falling over 20% from its early January peak. The market narrative explaining this weakness revolves around the coronavirus and its impact on the world’s largest energy consumer (China). My view is that this narrative is only partially true. While reduced demand in China would certainly be a negative, I think there is probably more at play here. The selloff began before the outbreak became a big story, and energy markets have been dealing with supply and demand imbalances for years as a result of the U.S. shale boom.

West Texas Intermediate (WTI), the U.S. benchmark for oil prices, has declined from over $60/barrel to below $50. Absent a brief period following the 4th quarter selloff in 2018, oil prices are hovering near the lowest levels since 2017.

Source: FRED Database & the U.S. Energy Information Administration. Data as of 2/10/2020

This decline has been painful for energy companies. The Energy Sector ETF (XLE) is down over 10% this year, meanwhile the S&P 500 is up about 4%. Pain in the energy sector, however, has less impact on the stock market as a whole than it used to. In 2009, companies in the energy sector made up nearly 12% of the S&P 500. The weight has since dropped dramatically, finishing 2019 at 4.3% and shrinking further in 2020.

Source: S&P Dow Jones Indices. Data as of 12/31/19. *Real Estate was spun off from the Financial sector post September 16, 2016. **Telecommunication Services was renamed Communication Services, with issues added from other sectors post September 20, 2018

Energy stocks typically carry a heavier weight in value tilted strategies, and have definitely detracted from performance. The silver lining here is that while most U.S. stocks are expensive, the energy sector is priced like a bargain. This should be a tailwind moving forward.

Source Morningstar Direct. The chart compares an equally weighted composite of P/E, P/B, P/S, and P/CF for the S&P 500 Energy index relative to the Russell 3000, which is used as a proxy for the U.S. Market.

Outside of the pain being felt in the energy sector, there is a positive side to falling oil prices. Costs for companies that use oil/energy as an input have declined, which could lead to improved earnings. Additionally, more than two-thirds of U.S. GDP comes from consumption. When costs at the pump fall, those savings can be applied to other discretionary spending. After last year’s peak at about $2.90/gallon, the average price in the U.S. has declined by about 16.5%. Prices in the Midwest have declined further, falling 17.9% to $2.32/gallon. This essentially equates to a tax cut for consumers, and is particularly beneficial for those on the lower end of the income spectrum. 

Source: FRED Database & the U.S. Energy Information Administration. Data as of 2/10/2020

Finally, I’ll leave you with this interesting chart from the U.S. Energy Information Administration (EIA). Ever wonder what goes into the price of gas?

WEEK IN REVIEW

  • One of the most closely watched pieces of economic data is the jobs report published by the Bureau of Labor Statistics (BLS) on the first Friday of every month. The February report, published last Friday, showed the U.S. economy added much more jobs in January (225k) than expected (158k). Much of the overshoot has been attributed to unseasonal warm weather that boosted hiring in the construction and leisure/hospitality sectors. The unemployment rate ticked higher from 3.4% to 3.6%, as more individuals were drawn back into the labor force and began looking for a job.
  • The market is expecting the Chinese government to step in with some additional monetary and fiscal stimulus to cushion the impact from the coronavirus. Stimulus is generally a tailwind for stock prices.
  • Data published by the Institute for Supply Management (ISM) for January showed the services sector grew at the fastest pace in 6 months.  The index increased from 54.9 to 55.5, versus expectations of 55.0 (anything above 50 signals growth). The services sector is much larger than the manufacturing sector in the U.S., and this data suggests no recession in sight. 

HOT READS

Markets

  • Tesla’s Stock price Can’t Be Justified. Stop Trying. (Barron’s)
  • The coronavirus is a ‘black swan’ for oil and energy markets, says Ned Davis Research (CNBC)
  • What to Watch for in China Stimulus as Virus Impact Hits Economy (Bloomberg)
  • U.S.-China Trade War Reshaped Global Commerce (WSJ)

Investing

  • Believe It or Not (HumbleDollar) Spotting narratives that are worth your attention, versus those that should be ignored
  • Bond Funds are Hotter than Tesla (Intelligent Investor) 1/8th of muni fund assets arrived last year

Other

  • Here Are the Most Common Airbnb Scams Worldwide (VICE)
  • Men’s College Basketball Has Been Chaotic. But Just Wait Until the Tourney (FiveThirtyEight)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

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

Financial Market Update + 2.18.2020

Financial Market Update + 2.4.2020

FINANCIAL MARKET UPDATE 1.21.2020

STORY OF THE WEEK

ANATOMY OF STOCK MARKET RETURNS

2019 was an excellent year for the stock market with many major indices, including the S&P 500, reaching all-time highs. Whether investors can expect such strong performance to persist depends on why returns were so strong in the first place. A simple analysis suggest the gains from last year are likely NOT sustainable.

Stock returns can be broken down into three primary components:

  • Earnings Growth(1)
  • Dividend Yield(2)
  • Valuation Change

According to data published by FactSet, 45% of companies in the S&P 500 have reported earnings for the 4th quarter as of last Friday (1/31). If you compare the actual results of the companies that have reported with estimates for those companies that have yet to report, earnings growth for 2019 is expected to be -0.3%. The dividend yield for the S&P 500, meanwhile, has generally fluctuated around 2% for the past couple of years. With the first two components making a negligible contribution, the S&P 500’s 31.5% return for 2019 was largely a function of valuation change. The chart below supports this idea. The price-to-earnings (P/E) ratio, a popular valuation metric that measures the price investors pay to participate in a dollar of business profits, increased substantially during 2019(3).

Source: Morningstar Direct. Chart reflects the P/E ratio for the S&P 500 index from 1/31/01 – 12/31/19.

The implication here is that the S&P 500 did not rise in price due to a tangible improvement in the underlying businesses. Instead, it rose simply because investors were willing to pay more for them. There were a few factors that contributed to this, including:

  • The selloff during Q4 2018 depressed the P/E ratio to a level slightly below the long-term average. Part of the increase was a function of recovering from that decline.
  • Investor sentiment became elevated late last year as news broke that the U.S. and China had reached a “Phase-One” agreement in trade negotiations.
  • Last year the Federal Reserve transitioned from tightening interest rates, to being on hold, to cutting interest rates by 0.25% three times. Lower interest rates are generally considered good for the stock market and supportive of higher valuations.

The valuation change that propelled the S&P 500 last year is NOT sustainable, because it tends to mean revert in the intermediate to long-term. To conceptualize what this means, think of it as a rubber band. When stretched, tension builds as the band wants to return to its normal state. While the forces causing the band to stretch can continue further than expected, the more stretched it gets the more likely it will snap back, and the more dramatic the snap will be when it does. It’s possible that valuations continue to stretch in 2020, but it’s not prudent for investors to expect this to happen. Meanwhile, the dividend yield on the market typically does not change much from one year to the next, and will likely remain in the low single digits. For sustainable market gains moving forward, we need to see businesses grow their earnings.

Notes:

1. A slightly more technical approach would be to separate real (inflation-adjusted) earnings growth from inflation.

2. Practitioners generally include the effect of net share issuance with dividends, referred to the combination as “Shareholder Yield”. When stock buybacks exceed new share issuance it is a positive for returns, while new share issuance exceeding buybacks would be a negative.

3. The P/E ratio is a valuation metric that is sometimes referred to as a “price multiple”, as it measures the price an investor must pay as a multiple of $1 of some fundamental metric. Revenues, cash-flows, or book-value are other types of valuation ratios. When these ratios increase, it is often referred to as “multiples expansion”.

WEEK IN REVIEW

  • Last Wednesday the Federal Reserve concluded its first policy meeting, and as expected left the benchmark federal funds rate in the current range of 1.50-1.75%. The Fed has failed to reach their 2% target on core Personal Consumption Expenditures (core PCE, their preferred inflation gauge) for an extended period of time. As a result they appear biased towards easy monetary policy as they continue to monitor the impact of 2019’s three rate cuts. According to data from the CME Group, the market is expecting the next move in rates to be a cut at the September meeting.
  • Four years after the U.K. voted to leave the European Union, Brexit quietly occurred on Friday (1/31). They have now entered a twelve month transition period, during which the two sides will negotiate a new trade deal that will govern their relationship moving forward.
  • The Bureau of Economic Analysis (BEA) published the first estimate of Q4 Gross Domestic Product (GDP). GDP, a popular representation of economic growth, came in at 2.1% and matched the pace from the previous quarter. Beneath the headline figure, the underlying details were not quite as strong. GDP got a large boost from net trade, caused by a sharp decline in imports. This is generally not considered a sustainable source of growth, and actually reflects weaker domestic demand. Other data published in the U.S. showed manufacturing activity unexpectedly increased in January. The Institute for Supply Management’s Manufacturing Index increased from to 50.9 from 47.8, and showed growing activity for the first time in 6 months (any read above 50 reflects expansion). This is welcome news, as manufacturing has been a real weak spot in the economy.

HOT READS

Markets

  • This Earnings Season Is Better Than You Think (Barron’s)
  • When Does the Federal Deficit Matter? (AWOCS)
  • Yield-Curve Inversion is Sending a Message (Bloomberg)

Investing

  • The Stock Got Crushed. Then The ETFs Had to Sell (Zweig)
  • 3 Big Themes in ETFs Right Now (ETF.com)

Other

  • How much Are We Paying For Our Subscription Services? A Lot (NYT)
  • The Illusory Truth Effect: Why We Believe Fake News, Conspiracy Theories and Propaganda (FarnamStreet)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

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

Financial Market Update + 2.18.2020

Financial Market Update + 1.28.2020

FINANCIAL MARKET UPDATE 1.28.2020

STORY OF THE WEEK

have stocks caught the coronavirus?

Coverage of the Coronavirus outbreak has been dominating headlines over the last few days, and the market seems to have taken notice. For the past several months the S&P 500 has steadily marched higher with very little volatility. That changed this Monday, when the index closed down -1.57%. The decline marked the first daily move exceeding +/- 1% since early October, ending one of the longest such streaks on record.

It is frightening to learn about a new virus that is spreading quickly and has no cure or vaccine. As of this writing, Coronavirus has claimed the lives of over 100 people, infected thousands more, and prompted the Chinese government to quarantine an urban area with a population comparable to New York City.  While the outbreak is undeniably having an adverse human impact, I question the idea that it will have a lasting effect on global stock prices.

To put this into context, consider the common flu (influenza). According to data from the Centers for Disease Control and Prevention (CDC), since 2010 the U.S. alone has had 9 to 45 million people contract influenza each year. Of those, 140,000 to 810,000 people required a visit to the hospital, and 12,000 to 61,000 have succumbed to their illnesses (each year!).  While the media focuses on the frightening new Coronavirus, influenza will likely have the larger impact.

Source: Centers for Disease Control and Prevention (CDC)  

Over the past 40 years we have seen more than a handful of viral scares. The table below, courtesy of MarketWatch, suggests the market impact of these events has historically been muted, even in the short-term. I’ll insert the generic disclosure here: past performance does not guarantee future results. It is certainly possible that Coronavirus will end up being a much bigger deal than these past episodes, though I’m not making that my base case.

In my view, the biggest ailment for the market is the fact that excessively bullish sentiment has pushed stock prices beyond what business results can justify (See the S&P 500 Trailing P/E chart in the Markets at a Glance section). When this occurs, the market generally becomes more vulnerable to a pullback. This is not necessarily a bad thing, however, as corrections are a normal and healthy development and can set the market up for continued gains. Pouring some cold water on investor sentiment may be just what the doctor ordered for your portfolio.  

WEEK IN REVIEW

  • Data published late last week showed an early estimate of January’s manufacturing sector activity, which declined to a three month low. The Manufacturing Purchasing Managers Index (PMI) fell from 52.4 to 51.7 (any reading above 50 signifies expanding activity). The Services PMI, however, accelerated from 52.8 to 53.2. The services sector is a much larger component of U.S. economic activity, and has offset weakness in manufacturing activity.
  • The Federal Reserve’s Federal Open Market Committee (FOMC) will conclude the first monetary policy meeting this week, with the policy announcement tomorrow at 1 PM CT, followed by Chairmen Powell’s post meeting press conference shortly after (you can stream it on Yahoo Finance). The market is not expecting any change to the current level of interest rates (currently at 1.5 – 1.75%).  
  • On Thursday we will get the first estimate of Q4 GDP. The Atlanta Fed’s popular GDPNow model is projecting growth of 1.9%, which would continue the trend of slowing growth that began in mid-2018.

HOT READS

Markets

  • What the 2020s Will Look Like For the Markets (AWOCS)
  • Ultrafast Trading Costs Stock Investors Nearly $5 Billion a Year, Study Says (WSJ)
  • Seth Klarman Passionately Defends Value Investing… (CNBC)

Investing

  • Here’s Why You Should Rebalance (MorningStar)
  • Why Invest? A 22-Year-Old’s Tough Questions About Capitalism (Zweig)
  • The Wager Revisited (HumbleDollar) Lessons from Warren Buffett’s bet against hedge funds
  • Big Mistakes, Don’t Make Them Yourself (Video) (Irrelevant Investor)

Other

  • The Buffett Formula: Going to Bed Smarter Than When You Woke Up (FarnamStreet)
  • SpaceX Crew Dragon Escapes Exploding Rocket (Heavy)
  • The 24 Stats That Explain Kobe Bryant’s Staggering Legacy (TheRinger)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

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

Financial Market Update + 2.18.2020

Financial Market Update + 1.21.2020

FINANCIAL MARKET UPDATE 1.21.2020

STORY OF THE WEEK

CASH CAN BE RISKY

By all accounts, 2019 was an excellent year for investors. Unless you hid your cash in your mattress, you likely earned a positive return on investment. Even if you hid your cash, you still didn’t lose money!  

2019 Returns by Asset Class

Source: Morningstar direct. Stocks were represented by the Russell 3000, bonds by the Bloomberg Barclays Aggregate Bond Index, Money markets by the Morningstar Taxable Money Market Fund Category, mattress was a Sleep Number 360® Special Edition Smart Bed.  

This snapshot of the market misses a crucial point, however, as it ignores the impact of inflation. People invest money today, so they can A) increase the quantity of goods and services that can be purchased in the future, and B) offset the impact of price increases over time (inflation). If the rate of inflation exceeds the return on an asset, the result is a loss of purchasing power. What ultimately matters for investors, is what happens to the purchasing power of their assets. The chart below illustrates the asset class returns after adjusting for inflation.

 

2019 Returns by Asset Class (Inflation-Adjusted)

Source: Morningstar direct. Stocks were represented by the Russell 3000, bonds by the Bloomberg Barclays Aggregate Bond Index, Money markets by the Morningstar Taxable Money Market Fund Category, mattress was a Sleep Number 360® Special Edition Smart Bed, inflation was the Consumer Price Index for All Urban Consumers (CPI-U)   

While the inflation adjusted-return, also referred to as the “real” return, remained positive for stocks and bonds, money market funds (invested cash) and your mattress (idle cash) lost value in terms of actual purchasing power. I would include traditional checking, savings, and brokerage sweep accounts as idle cash. Their returns were closer to what you would earn keeping money in your mattress versus a money market fund (or similarly high yielding account). The Consumer Price Index (CPI), a popular measure of inflation, increased by 2.3% in the 12 months ending last December, and has been trending higher. Meanwhile, the Federal Reserve lowered interest rates three times last year, which lowered the prospective return on invested cash. Even longer term bonds carry yields below the current level of inflation (see the Yield Curve Comparison chart in the Markets at a Glance section). The bottom line is even the most conservative investors can benefit from owning at least a little bit of stocks in their portfolio, given the risk imposed by inflation on future purchasing power.

WEEK IN REVIEW

  • Last week was positive for markets with most major asset classes gaining, and major U.S. equity indices reaching all-time highs. The S&P 500 has closed at a new high in six of the twelve trading sessions thus far in 2020.
  • The largest news from last week related to the signing of the trade deal between the U.S. and China. The deal is more like a ceasefire, as it does not address some of the trickiest issues on the table. The market response to the signing was muted, as most of the gains came on the announcement that the two sides were close to a deal.
  • As we move into the new week, fears have surfaced related to a spreading virus in China (reminiscent of SARS in 2002) that could impact travel and tourism heading into the Lunar New Year (Asia’s busiest travel period of the year). Additionally, Moody’s Investors Service downgraded Hong Kong’s credit rating in the wake of ongoing social unrest in the city. On Friday we will get a flash (early) look at activity in the manufacturing and services sectors when data provider Markit publishes their Purchasing Manager Indices (PMI).

HOT READS

Markets

  • Is This As Good As It Gets For the Stock Market? (Irrelevant Investor)
  • China Trade Deal Looks Like a ‘Modest Positive.’ But Large Uncertainties Remain (Barron’s)

Investing

  • You Bet! (Howard Marks) Similarities between investing and games of chance (gambling)
  • Apple and Microsoft Are Dazzling Investors. That Won’t Last (Zweig)
  • Reports of Value’s Death May Be Greatly Exaggerated (Research Affiliates)
  • CASPERhaps (Scott Galloway) Prof Galloway doubts Casper can IPO

Other

  • Good Science, Bad Science, Pseudoscience: How to Tell the Difference (Farnam Street)
  • The Secretive Company That Might End Privacy as We know It (NYT)
  • Visualizing the Biggest Risks to the Global Economy in 2020 (Visual Capitalist)

LFS BLOG

  • Are We Headed for a Recession? (Lutz.us)
  • Is Value Investing Dead? (Lutz.us)
  • Why Investors Should Own International Stocks (Lutz.us)
  • 3 Things All Investors Should Know (Lutz.us)

ECONOMIC CALENDAR

Economic Calendar

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

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

Are We Headed for a Recession?

Are We Headed for a Recession?

 

LUTZ BUSINESS INSIGHTS

 

Are we headed for a recession?

josh jenkins, cfa, senior portfolio manager & head of research

 

Each morning I craft a Market Update email that I share with our advisors. This email provides commentary on what is happening in the markets and the economy. It includes data related to asset class performance and economic indicators, and links to some top stories that I think are interesting and relevant.

As I review the daily news flow, I consistently come across articles that suggest we are entering a recession. It’s not surprising the financial media focuses on this topic. Their business model is reliant on attracting eyeballs for advertisers. Nobody is going to click on an article titled “We Don’t Know Why This Happened, and it’s Not Important.” Fear sells. You get people’s attention when you tell them the economy is heading for ruin and it’s taking investors down with it.

In light of the barrage of negativity in the financial news, we frequently field questions from our clients related to recessions. “Is one coming? If so, when? And what does this mean for my investments?” One of these questions can be answered with a level of certainty. The other two cannot. I’ll address each question below.

Is a Recession Coming?

Yes, a recession is coming. We know this to be true with some level of certainty. The economy is cyclical, oscillating between periods of expansion and contraction.

The table below illustrates the 15 recessions the U.S. economy has endured over the last (roughly) 100 years. On average, they have lasted one year and two months. They have been as short as seven months (the early 1980s) and as long as three years and eight months (the Great Depression).

Source: FRED Database. Recession indicators calculated by NBER based on peak through trough. Data from February 1926 through August 2019.

The table also illustrates the average expansionary period has lasted five years and three months. Frequently referred to as “bull markets,” the expansions have varied widely in length. They have been as short as eleven months, and as long as ten years (and still going).

Despite the variation among the bull markets, they do share one common trait. At a certain point, every one of them eventually came to an end. One hundred years of data suggests the current expansion will meet the same fate as those that preceded it.

When Will the Recession Begin?

While it is easy to understand that a recession will come, it is much more challenging to accurately predict WHEN it will happen. A few pundits, economists, or investors may correctly foreshadow a large downturn, but it is seldom the same group from one episode to the next. There is little evidence that it is possible to consistently anticipate change in a system as large and complex as the economy or stock market. A common industry tactic is to call for a recession one to two years down the road. Eventually, they’ll be proven right! But how long are they wrong before that happens? Sitting on the sidelines during an upmarket carries a high opportunity cost.

We have already discussed the media’s pension for alarming headlines. As we pulled out of the last recession, they wasted no time speculating on the next one:

  1. “Dr. Doom Sees Double-Dip Recession Risk, in Remarks Down Under” (WSJ, 8/3/2009)
  2. “Double-Dip Recession Fears Creep Back Into the Market” (CNBC, 2/25/2010)
  3. “On the Verge of a Double-Dip Recession” (NY Times, 9/7/2011)
  4. “Earnings Show Recession May be ‘Fast Approaching’” (CNBC, 7/22/2012)
  5. “U.S. Recession is Nigh… and the Fed Can’t Stop It: SocGen’s Edwards” (CNBC, 11/28/2013)
  6. “Can The Fed Stop The Next Recession? Business Can’t Bank On It” (Forbes, 2/23/2014)
  7. “It’s Time to Start Talking About a U.S. Recession” (Business Insider, 10/11/2015)
  8. “A Recession Worse Than 2008 is Coming” (CNBC, 1/15/2016)
  9. “U.S. Heading for Recession After 2 Years of Unsustainable Growth, Economist Says” (CNBC, 3/28/17)
  10. “Another Warning that a 2019 Recession is Coming” (Forbes, 12/17/2018)
  11. “Parts of America May Already Be Facing Recession” (The Economist, 8/31/2019)

Despite the bad news prompted these stories, both the economy and stocks continued their ascent:

 

Source: FRED Database and Morningstar Direct. The stock market is based on the growth of $10,000 invested in the S&P 500 TR Index. The Economy is based on the Bureau of Economic Analysis’ Real GDP in Billions of 2012 Chained dollars. Data from July 2009 through June 2019.

Earlier this year the current bull market became the longest on record, surpassing the nearly ten-year expansion that spanned the 1990s. The record has sparked a commonly held view the expansion cannot keep going, simply because one has never lasted this long before. On the surface, this view makes sense, but it ignores a critical variable. It considers the length of time the economy has been expanding but overlooks the rate of change. 

 

Source: FRED Database. The Length of bull markets was calculated with the NBER based on peak through trough recession indicators. Start and end dates were rounded to the nearest quarter. GDP is based on the Bureau of Economic Analysis’ Real GDP in Billions of 2012 Chained dollars. Data from Jan 1947 to June 2019.

As it turns out, the economy has been growing at a much slower pace than in past expansions. In fact, it has not even cracked the top three in terms of cumulative GDP growth. This steady pace could suggest the economy has more room to grow before the imbalances that contribute to a recession begin to form.

How Will a Recession Impact My Investments?

What if I told you that I knew with certainty which month the recession would begin? How much do you think you could profit from this knowledge? I think the typical investor would expect to improve their investment returns dramatically with this information. After all, stock prices plummet during recessions, right? A review of history shows us that reality is not that simple. You may be surprised to see equity returns were positive during eight of the last fifteen recessions, and the median return during these episodes was +4.1%!

 

Source: FRED Database and Morningstar Direct. Recession indicators calculated by NBER based on peak through trough. Stock market returns were calculated using the IA SBBI Large Cap Index. Data from February 1926 through August 2019.

It is important to understand that the stock market is a discounting mechanism. Stock prices represent an aggregation of all current information, as well as expectations about the future. As a result, market returns can and will deviate from the real economy.

Amid substantial economic growth, the market may anticipate there is trouble ahead, leading to lower prices before any actual contraction in economic activity occurs. Conversely, during the depths of a recession, the market may anticipate better times ahead, leading to higher prices prior to the resumption of growth.  In the case of a mild economic downturn, the market may assess that the long-term prospects for businesses may not be so impaired that a large (or any) devaluation is necessary.

While recessions share common features, no two are exactly alike. The playbook that was successful during the last contraction may not work the next time. Selling out at the onset may have allowed you to avoid some pretty severe drawdowns, but it also would have caused you to miss out on significant gains.

A third of the recessions in the above table coincided with the stock market generating double-digit returns. This is illustrative of why market timing is so hard. Not only must you accurately foresee the event, but you must also correctly gauge the market’s reaction to the event. You then need to time your entry back into the market successfully. It does you no good to sell your investments ahead of a 20% drawdown, to then miss out on a subsequent 30% recovery.

Preparation is Key

It is critical for investors to prepare for the next recession. Preparation, however, may not entail what you think. It has nothing to do with forecasting when a recession will hit or standing ready to sell out of your investments ahead of the next big drawdown. Preparation means sitting down with a financial advisor, mapping out your goals, and devising a plan you can stick to.

At Lutz Financial, we believe the best approach is to hold a low cost and well-diversified portfolio that is appropriately calibrated to your goals and risk tolerance. The beauty of this approach is you don’t have to play any guessing games. Although your investments will experience volatility from time to time, you can take comfort in knowing it can weather the storm. While we don’t know when it will begin, the next recession is inevitable. Are you prepared?

 

 

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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

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