| 2nd Qtr.
| 12 Mo.
|10-yr Treas. yield||2.00%||2.41%||-0.41%||2.85%||-0.85%||-0.69%|
|Fed funds rate||2.25-2.5%||2.25-2.5%||n/a||1.75 – 2.0%||+0.50%||n/a|
(stock indices are before dividends; yield and rate changes are absolute changes)
The change in expectations from the Fed raising rates more in 2019 to actually cutting rates to keep the economy growing caused the stock market to shrug off the impact of the trade war with China and push the S&P 500 to new highs. The first half of 2019 was the best first half for US stocks since 1997. The benchmark 10-year Treasury closed right at 2% after sliding below that level in late June, the lowest level since November 2016 and well off the recent high of 3.23% in early November 2018.
Despite concerns that the government shutdown would hinder growth, the final growth figure for the first quarter came in at 3.1%, a solid increase from the 2.2% in the prior quarter. The International Monetary Fund cuts its global growth estimates for the year to 3.3% from 3.5% because of growing trade disputes but the US has managed to buck the slowdown so far.
The housing market remained tight with pending home sales declining from the prior year for 17 months straight. Purchases of homes by investors were 11% of all transactions in 2018, an all-time high and going higher, especially at the lower end of the market where 20% of purchases were by investors. Core business investment in May was the best this year and 1.4% over last year, although April’s figure was revised lower. Durable goods orders bounced around each month but are on a slightly positive trend although manufacturing sentiment was at its lowest level since 2009.
The May jobs report was weak, with only 75,000 new jobs, and both March and April were revised lower. The June report was a strong rebound, with 224,000 new jobs and increasing the monthly average for 2019 to 172,000 compared to 223,000 for 2018. Unemployment went up to 3.7% and participation was flat while hourly earnings increased 3.1% from the year prior. Consumer confidence stayed high but “expectations” declined and were the weakest in two years. Total US household debt is now $1 trillion higher than the peak in 2008 and delinquencies for credit card and student loans are rising; almost 10% of student loans are over 90 days past due and that is understated as half of student loans are in deferment and don’t require payments.
Productivity increased at the highest rate in four years in the first quarter, at 3.6%, and the 12-month increase of 2.4% was the best in nine years; the annual average was only 1.3% from 2007 to 2018. Productivity gains are essential to continued growth and help keep labor costs, which actually fell, under control. One demographic trend that could impact consumer spending is declining US births, which hit a 32-year low, and an all-time low fertility rate (births per 1,000 women ages 15-44). The average age of all women giving birth is approaching 29 years, an increase of four years since 1968. Teen births are way down and the only increase is in ages 35 to 44.
The Fed has returned to the forefront of the market expectations, with Chairman Powell acknowledging that risks have increased since the beginning of the year with escalating tariffs and slowing global growth. Although the Fed sees the economic “baseline” as still favorable they also emphasized their independence by reaffirming that their decisions will be driven by policy and not politics. The word “patient” was replaced with “closely monitor” in Fed statements as a recognition that uncertainties have increased; for Fed watchers this qualifies as a major shift.
The yield curve inverted again in the middle of May (10-year Treasury Rates fell below the 3-month rate) and stayed inverted for the remainder of the quarter, leading to a current market consensus of a nearly 100% chance that there will be a cut in short-term rates in July. Unfortunately, market sentiment is notoriously bad at predicting Fed moves, with fed funds futures expecting rate increases throughout the seven-year period of zero rates and underestimating rate increases over the last several years. Why would the market be right today with its expectations for two rate cuts in 2019?
One of my professors claimed that only two people in the world understood currency exchange rates and they disagreed. That may be overstated but exchange rates are notoriously complex because they incorporate not only the emotions of the markets but also the intertwined, complementary and conflicting economic developments of all the major countries at the same time.
Here are just a few of the global economic and political issues that are baked into exchange rates:
• The yields on 10-year government bonds are negative in Germany, Japan, Denmark and Netherlands.
• The European Central Bank has floated the possibility of lowering their rates in an attempt to make the euro attractive.
• The US and Mexico reached a deal in June that avoids more tariffs between the two countries, although the issue at hand was immigration and not trade.
• Brexit has yet another deadline of October 31 as Prime Minister May has resigned pending the election of a new leader. (Our conversations with some Brits on our recent trip to Europe confirmed that May had angered all sides although it could be argued that she was put in an impossible situation by the voters in the first place.)
• The US and China announced a “ceasefire” in their trade war, leading the markets to anticipate an actual resolution.
• The May trade deficit for the US was the highest in 2019 with exports increasing at the highest rate in 12 months but imports increasing even more.
With all those moving parts, the US dollar has been strong on the strength of our relatively high economic growth rate compared to the rest of the developed world. The USD has strengthened against many of the other major currencies in 2019 – the euro, the British pound sterling, the Chinse yuan – and is flat or slightly down against the Japanese yen (how to explain that?), the Canadian dollar and the Swiss Franc. While the closest most consumers will get to really understanding exchange rates is travelling internationally (it was great for us in Spain), currencies should impact imports, exports and the trade deficits. It may be that businesses are just as confused as the rest of us and have greater problems to figure out and so are just absorbing currency fluctuations. That can’t go on forever, though, so the strength of the USD could be a major factor if the economy slows.
Advertising by planners and advisors often catches our attention, not just for competitive business purposes but because we are concerned with how the public is being enticed and, in some cases, misled.
One firm from Phoenix has been advertising heavily in Tucson around two themes. The first pitch is that they can place investors in annuities with “a 10% guaranteed increase in income”, which sounds almost too good to be true. But annuities are basically a series of actuarial calculations based on life expectancy and an assumed investment return for the insurance company issuing the annuity, so any annuity that includes increases in the annuity payments will have a significantly lower payment amount in the early years. This feature may actually work well under some circumstances but without a full comparison of various annuity options the average person will de distracted and persuaded by the allure of increased income. As we have repeatedly emphasized, we don’t rely on investment characteristics that mask some other aspect that is detrimental.
The second pitch is that this firm will create a “personalized portfolio” for its clients. Does that mean each portfolio is totally unique from any other or is it like the old Newlywed Game (“a grand prize selected especially for you”, which somehow always turned out to be a washer and dryer).
In practice, a truly personalized portfolio is not only impractical but does not add any value. Even with sophisticated data analysis, an investment manager can’t responsibly track thousands of investments. And if an advisor concludes that an investment is attractive, shouldn’t it be available to all clients? Personalization could include the exclusion of certain companies or sectors but even that can’t be too specific because many companies are so diversified that they could be excluded for multiple reasons. And the evaluation of companies can be extremely subjective; for example, large technology companies may seem to be a safe bet but there are concerns with privacy and user manipulation so would those companies be considered “responsible” or not?
Personalization comes more from the interaction of the portfolio with the client’s needs and goals than from the construction of the portfolio itself. That means the timing and impact of adding to or withdrawing from the portfolio is unique and the way we communicate with and educate each client about their portfolio is personalized to their level of experience and understanding. Our portfolios are mostly composed of the same funds because we believe they are relatively predictable given their market areas and they work well together in a diversified portfolio. The allocations of these funds changes with the client’s risk tolerance and long-term objectives, not with short-term market, economic or political developments.
What are the fees for the privilege of working with the Phoenix firm? Up to 2%, which is double what most advisors and planners charge. Ouch.
Home Semi-Sweet Home
Home ownership has long been seen as a step to financial security as well as contributing to family stability and community involvement. In lieu of owning a home, stable rental housing can at least offer many of the same community benefits. Of course, the path to stable housing can shift dramatically, as we painfully experienced during the housing bust and great recession of the late 2000’s. How does today’s housing market look?
The Joint Center for Housing Studies at Harvard University issues an annual report known as The State of the Nation’s Housing. The report covers many topics from the cost of land to details on home purchasers but in 2018 it is clear that the way housing is created in the US creates problems for both potential homeowners and renters.
Vacancy rates are very low and in the basic law of supply and demand, high demand and low supply means prices will go up. The vacancy rate for owner-occupied homes, at 1.5%, was the lowest since 1995 and the vacancy rate for renters was even lower, matching the lowest level since 1985 at 6.9%. That tight market has led new construction to focus on higher-cost units. In 2017, the supply of newly built homes renting for less than $800 fell by 1 million and in the first quarter of 2018 only 9% of new rental units had rents below $1,050.
Affording rent has becoming an increasing burden for many, with 22% of renters paying between 30% and 50% of their income on housing costs, while one-quarter are paying more than 50%. Not surprisingly, that burden falls more heavily on low-income renters, with over 70% of renters with income of $15,000 or less spending more than 50% of income on housing.
Those high rents have other consequences. Younger people delay forming their own households and becoming independent, especially in higher-cost areas. Cost-burdened renters have less money to spend on other things, including some essentials like health care, where they spend ¼ as much as other renters. Even access to jobs is affected, with unburdened renters able to spend three times as much on transportation.
Rising housing prices mean that homeowners are better off, with home equity rising and the number of cost-burdened homeowners at the lowest level of the 2000’s. But affordability of housing has gotten tighter, even with low interest rates. The National Association of Realtors’ housing affordability index uses median house prices, median family incomes, federal mortgage rates, a 20% down payment and a threshold of 25% of family income for principal and interest payments. At the national level the index looks good, with both first-time homebuyers and all homebuyers having around 150% of the income needed to afford a home. Even those positive index readings, though, dropped 20% from 2016 to 2018.
And as the saying goes, all real estate is local, and those national numbers hide a huge disparity. The most affordable housing areas (Elmira, NY, Youngstown, OH and Peoria, IL) all had an affordability index over 300, which means the median income was 300% of the amount necessary to purchase the median home. At the other end of the spectrum, Anaheim/Irvine and Los Angeles/Long Beach had index readings around 61, which means that the median income could cover only 61% of the principal and interest of the median home. Many of the other cities that are considered desirable, especially with younger workers, either have index readings below 100 or have had the biggest declines in affordability. (Just for reference, Tucson’s affordability index fell from 173 in 2015 to 150 in 2018.)
Some of this is to be expected – the economy is strong, construction workers are scarce (despite steady increases, construction employment is still well below its 2007 level) and there is a lower limit on the cost of habitable rental units, so lower income people would understandably pay more of their income. Without some amount of affordable housing, however, any number of problems will be more difficult to solve.