| 3rd Qtr.
| 12 Mo.
|10-yr Treas. yield||1.675%||2.00%||-0.325%||3.06%||-1.385%||-1.015%|
|Fed funds rate||1.75-2.0%||2.25-2.5%||-0.50%||2.0 – 2.25%||-0.25%||-0.50%|
(stock indices are before dividends; yield and rate changes are absolute changes)
Performance for stock markets was not great for the quarter, nor for the trailing year, but how about those year-to-date numbers? If anything, they illustrate the vagaries of market volatility, but the S&P 500 posted its best first half numbers since 1997 along with strong showings by bonds and commodities. This somewhat unusual mix of risky and safe markets showing strength reflects uncertainty and confusion over trade issues and the prospects for interest rate changes. With two cuts to digest, the yield curve was inverted for the entire quarter. The 30-year Treasury bond yield hit an all-time low and the 10-year yield went as low as 1.47% before rebounding, although each day seemed to bring news that shifted market sentiment.
The trade war with China began to have real impact on the market and the economy. In August, Chinese State-owned firms announced they would suspend imports of US agricultural products and President Trump “ordered” US companies to create alternatives to Chinese operations. The Chinese currency reached its lowest level to the US dollar in 11 years and China is no longer the top US trading partner, surpassed by both Mexico and Canada. In September, the trade war cooled as some new tariffs scheduled for December 15 were delayed and high-level meetings were planned. The US manufacturing sector contracted in August after 35 months of expansion and hit its worst reading in 10 years in September. Services continued to expand but also hit a three-year low in September.
The job market has held up, adding 161,000 jobs per month in 2019, well above the 100,000 needed to support growth, and the unemployment rate fell to 3.5% for September. Monthly jobs are down, though, from 223,000 per month in 2018 and wage growth slipped below 3% in September. Housing starts and permits jumped in August while average home prices slowed for the 15th month in a row, although prices are still 15% over the prior peak and 58% above the recession trough. Existing home sales were up 2.6% YOY and prices were up 4.7% but inventory continues to drop; new home sales soared in August. Second quarter GDP growth settled at 2%, down from 3.4% in the first quarter but still up 2.6% for the first half.
The consumer chugged along, with spending up 4.6% in the second quarter and consumer debt excluding mortgages going over $4 trillion, its highest level ever; debt growth is still driven by car and student loans. Consumer confidence skidded to recent low but is still strong by historical standards. Productivity gains were 2.9% for the first half, well above the 2.1% long-term average and the paltry 1.3% since 2001. Business investment was flat in July and slightly down in August and core inflation was up 2.4%.
Let’s not forget the sideshow known as Brexit. Boris Johnson became the new prime minister with a pledge for leaving the European Union on October 31 whether there is a deal or not. He promptly lost a series of legal and legislative battles and it will take a miracle, or a major capitulation by the EU, to salvage an orderly transition. The British pound hit a 34-year low against the dollar and October 31 could be quite dramatic.
It’s hard to get off interest rates, as the Fed reversed course this quarter with two cuts. President Trump has been relentless in his criticism that rates should be cut, as well as personal attacks on Fed chairman Powell. The Fed is steadfast in proclaiming its independence from political preferences but even if the cuts are based solely on the Fed’s reading of the economy, it looks coincidental and creates an opportunity for President Trump to claim that he influenced the decision. (President Trump also decries the strength of the US dollar, but you can’t have a strong economy, especially compared to other developed economies, without a strong currency.)
The Fed shifted from merely acknowledging the global economic slowdown and the escalating trade wars, to practicing “risk management” by only cutting 0.25% in July and not appearing too aggressive, to its second rate cut on weakening business investment and the trade wars. Throughout, the Fed assured markets that it will act as appropriate to sustain expansion. The Fed will end two months early its program to reduce its balance sheet by not reinvesting the proceeds of maturing bonds and will now reinvest those proceeds in Treasury bonds, so mortgage holdings will still be going down.
Government spending is continuing unabated, with Congress reaching a deal with the administration that suspends the debt limit for two years and avoids any government shutdowns. Spending will increase $50 billion in the next year and will be $320 billion over the suspended limit over the next two years. There will be no action taken to reduce the deficit during the suspension and total Treasury borrowing for fiscal 2019 will be over $1.2 trillion, up from $546 billion in 2017.
Add to the drama the new drumbeat that negative interest rates in the US are a real possibility. Negative rates (depositors lose money by keeping money in banks and borrowers “make money” because their loan payments reduce the loan by more than the payment amount) have spread across the developed economies, with nearly $20 trillion of foreign government debt at negative rates. The European Central Bank signaled its first rate cut since 12016 and its rates are already at -0.4%. Negative rates would be uncharted territory for the US and the biggest problem is that the normal tool for managing the economy – interest rates – would no longer be available. Central banks have essentially thrown in the towel when rates go negative.
The Fed also intervened in the market for overnight borrowing among banks and short-term investment funds, including money market funds. High issuance of corporate debt and tax payments by corporations sucked up cash and dried up the liquidity in what is known as the repo market (for repurchase agreements) and overnight rates spiked to over 6%. The Fed injected $75 billion a day for over a week to support the market, all the while insisting it was a temporary structural problem and not an ongoing collapse.
We often talk about how we don’t manage portfolios, including investment strategies and vehicles that we don’t feel really contribute to the portfolio’s long-term effectiveness. Sure, any investment strategy may have its day, but that success is typically fleeting and catching those strategies at the most opportune time is random. We aren’t fans of random.
Here is a sample of unsolicited emails we receive regarding investment “opportunities” – and these are just the last two weeks.
• Structured products: Advisors are using structured products as a way to get market participation with potential for a level of protection at maturity. (These products are tied to the performance of some other security or market, cannot be sold before a maturity date and are an obligation of an investment bank. If you want to own something, just own it without complicating it.)
• Go beyond traditional investments – Recession worries. Trade troubles. Uncertain interest rates. Finding opportunities that can help diversify and grow your clients’ portfolios in today’s environment is critical to managing both investors’ concerns and increasing volatility. (If that’s not a fear-based pitch, I don’t know what is. For portfolio managers, the fear is that clients lose confidence, so the pressure to just DO SOMETHING is great, even if that action does not add value.)
• Net Lease Real Estate -a fully liquid, public real estate strategy that is value focused, and providing income. The ETF encompasses a variety of REITs that provide sustainable cash flows by leasing their properties through long-term contractual leases on a triple-net lease basis and is the only product of its kind on the market. (The index for the REIT has only been in existence since December 2018; all performance prior to that is “back-tested”, which is a fancy way of saying it is not real.)
• Leading Companies in Cannabis: The ETF seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Cannabis Index. (The ETF launched in September 2019 with $2 million in assets. The average company in the fund is losing money at a rate of one quarter of its stock price.)
• Tactical Market Neutral Fund – seeks asymmetric exposure to the equity risk premium but with significantly lower volatility than equities and low correlation to equity and bond markets (their emphasis). (Another jargon way of saying participate in stock gains but avoid declines; the fund has less than $4 million in assets, holds over 40% of the fund in cash and has expenses over 3%.)
In fairness, we are also contacted regularly by well-established money managers who have proven track records. But even those track records are not enough to persuade us to change our straightforward, consistent approach.
Nothing New Under the Sun?
It is only human nature to be focused on the present and the pain and pleasure that those circumstances carry. And in this polarized world, even history does not escape. Are we in the Santayana camp (“Those who do not learn from history are doomed to repeat it”) or inclined to the opposite (“It is not the past that matters but the future”?) Of course, these ideas are not mutually exclusive, but it is hard to ignore that history does repeat itself.
Here are just a few examples pulled from a history section that accompanied the 130th anniversary of the Wall Street Journal, which debuted in 1889.
Today’s issue: The safety net for retirees is in jeopardy.
WSJ report from February 27, 1975: Social Security System Is On Its Way To Going Broke; Who Should Foot The Bill?
Today’s Issue: 5G broadband will vastly improve technology and communications but it is costly.
WSJ Report from March 16, 1964: Global Direct Dialing Plans Laid by Phone Experts of 68 Nations; Group Says 12 Digits Could Dial Most World Telephones
WSJ Report from December 21, 1948: AT&T Pushes Biggest Expansion Ever Swung By Private Corporation; Installs 65,000 Miles of Cable Since War; 1,250,000 Still Await Phones
Today’s Issue: Technology and robotics will displace many workers.
WSJ Report from September 6, 1972: Click, Whir, Thanks; Many Banks Switching to Electronic Tellers That Are Always Open
Today’s Issue: Index funds are taking over the market, with potential risks.
WSJ Report from March 21, 1977: Wall Street’s New Fad Has People Watching Stock Market Scales; Money Managers Try to Keep Portfolio Balances in Line with S&P Index Ratios; A Way To Attain Mediocrity?
Today’s Issue: Popular culture is fraying society (isn’t it always?).
WSJ Report from February 12, 1964: The British Invasion; The Beatles Craze Threatens Big Dent in Parents’ Wallets; Wigs Go Over Big in Gimbel’s
Today’s Issue: Corporate power and influence is becoming too concentrated.
WSJ Report from May 16, 1911: Standard Oil Co. Dissolution Ordered by Supreme Court
We have been through many things before and survived, either through direct improvement, unexpected external forces or simple perseverance. It would be foolish to think that the same solutions would work for these ongoing problems, but it might help to acknowledge that this too shall pass.