Stocks Rebound As Economy Stagnates
/Have a great month,
Brian E Betz
Principal
Another Two Steps Backward For Stocks
/Have a great month,
Brian E Betz
Principal
Home Prices Slow As Interest Rates Rise And Stocks Fall
/Have a great month,
Brian E Betz
Principal
Stocks Fight Back Amid News Of Recession
/Have a great month,
Brian E Betz, CFP®
Principal
10 Years Ago This Week...
/It is hard to believe that 10 years ago this week marked the beginning of the global financial crisis.
On Sept. 15, 2008 the financial services firm Lehman Brothers filed for Chapter 11 bankruptcy. It remains the largest bankruptcy in history. At the time, Lehman was the 4th-largest investment bank in the world, with $600 billion in assets and 25,000 employees.
The main culprit was Lehman's exposure to mortgage-backed securities. Mortgage-backed securities are a type of investment where the investor is paid a return based on the reliability that mortgage debt holders will make their house payments. The financial firm (i.e. Lehman) essentially serves as the intermediary, whereby the investor is the one effectively lending the money to the homeowner, in exchange for the interest payments the homeowner makes against their mortgage.
Seems harmless enough, right?
As housing values rose in the 2000s, lending standards loosened. Prospective home owners with poor credit started being approved for mortgage amounts they could not afford. These riskier loans were dubbed "subprime" due to the higher default risk. Problems arose as mortgage-backed securities extended more and more to these subprime loans. It was a recipe for disaster.
Sure enough, just as the housing market cooled and unemployment spiked in late-2007, homeowners started missing their mortgage payments. Delinquencies led to loan defaults. A domino effect ensued, causing mortgage-backed securities to plunge in value. This led to the demise of many large financial firms, and ultimately, a collapse in the U.S. stock market.
It took nearly 5 years for the market to fully recover to where it had peaked in 2007. Since that recovery point in Aug. 2012, stocks have mostly continued to climb higher, although there have been some notable drops in the Summer of 2015 and early-2018. History suggests we are closer to the next recession than the last, but it will likely be a while given that stock prices remain near all-time highs.
In The Market...
The S&P 500 fell -1.0% last week. Let's look under the hood:
(price data via stockcharts.com)
It was a crummy week. In fact, it was the worst since June. But I suppose if a one-percent down week is the current definition of "crummy" then in the broader context things are pretty good. Both stocks and bonds were broadly down. Our Technology position got dinged pretty good, although our Utilities position was up more than +1.0%.
The losses in the bond market are noteworthy, mostly due to how quiet bonds have been the past few months. Something to watch in the coming weeks.
In Our Portfolios...
What's New With Us?
I watched the Seahawks lose a frustrating game, in between a lot of yard clean-up. A pretty uneventful weekend for me, but it is nice to have football back.
Have a great week!
Brian E Betz, CFP®
Principal
The Bond Market Problem That Is Not Going Away
/The bond market keeps inching closer to rare territory.
Interest rates are rising across the board. Normally this would be just fine, if not for the fact that short-term rates are rising much faster than long-term rates. This poses a unique situation/problem in the weeks ahead.
The 10-year Treasury bond rate sits just above 3.0%. The 2-year Treasury bill rate is not far behind at 2.6%. If short-term rates eventually eclipse longer-term rates (as shown below), it would mean that the yield curve has "inverted" from a traditional curve. Normally, the longer the bond maturity the higher the interest rate, and visa-versa. Take a look at how the 2-year yield (orange line) has closed the gap versus the 10-year yield (blue line):
(chart created in stockcharts.com)
Notice how quickly the short-term rate has risen relative to the long-term rate? Yield curve inversion could be near.
So is yield curve inversion bad? Potentially, yes. Last month I wrote about this dark cloud of inversion that is hanging over the market. It is often the precursor to a change in the business cycle, which can signal that economic contraction is looming, as it did in the early 2000s and 2008. Take a look at how the stock market (S&P 500, green line) reacted once short-term rates hit their apex in these previous two instances:
(chart created in stockcharts.com)
The two regions shaded in red show where the 2-year Treasury rate peaked, followed by a decline in the U.S. stock market soon thereafter. Before going any further, let's be clear: None of this guarantees that short-term rates have peaked or that the yield curve will invert. Have those odds increased? Yes.
So what would have to happen from here for those two things to occur?
For the yield curve to invert, investors would essentially have to prefer owning long-term bond investments to shorter-term bonds. This would imply that they are comfortable tying up their money for longer periods of time. Such long-term bond demand would push corresponding yields lower. Meanwhile, if short-term rates continue rising -- likely through the influence of the Federal Reserve -- eventually the 10-year rate and the 2-year rate would criss-cross and the result would be inversion.
In a perfect world, long-term rates would continue rising at a pace consummate with short-term rates until business conditions tighten. This tightening could take a number of forms, such as a decline in corporate revenues/profits, a rise in unemployment or flattening wages. As the economy reaches that cyclical peak and then starts to decline, interest rates would then slowly come back down. Lower interest rates would then (in theory) stimulate greater investment via lending and borrowing, which would lead to the start of a new economic upswing.
We know it is never this clear-cut. So if we are looking for the answer to "Is this the market top???" you are not going to find it here. What I would say is this... If the market and economy are nearing a top, I would expect stock prices to remain flat as interest rates creep higher. Eventually, financing would become too expensive and investors would pull back from investing.
But the elephant in the room that might precipitate all of this is that relationship between short-term and long-term interest rates. Long-term rates are meant to be higher than short-term rates, for the simple fact that long-term investments carry greater risk, and therefore, should pay the investor a higher interest return. But if investors decide they are willing to tie up their money for a longer period and only earn a tiny spread for doing so, the yield curve would likely invert. Then it is anyone's guess what immediate impact that has on the stock market and the economy at-large.
In The Market...
The S&P 500 fell -0.5% this past week. Let's look under the hood:
(price data via stockcharts.com)
Stocks just could not maintain the momentum generated coming off the previous week's gains. All in all it was a pretty quiet week for stocks. With interest rates on the rise, dividend-paying sectors (Utilities, Real Estate) were the worst performers. Energy and Materials were the big winners. We are still looking to buy into the Energy sector but would like to see prices come down a bit first before doing so.
In the meantime, as you see below we purchased a Consumer Discretionary fund (XLY) for many accounts. This sector appears poised to make a move higher and based on our technical evidence it made sense to try and take advantage of that.
Finally, to no surprise bonds were down virtually across the board. Long-term Treasuries and Corporate Bonds were both down more than -1.0%. We continue to own a small position in each of these areas in most accounts. I will be looking to sell our Corporate Bond position in the coming week but will likely be a bit more patient with our Treasury position.
In Our Portfolios...
What's New With Us?
I am thrilled to announce that Joshua Baird will be joining our team next month as Executive Administrative Assistant! Josh is a graduate of Pacific Lutheran University and someone I am confident will bring great value and intellect to our firm in the months ahead. I am sure you will have a chance to meet and interact with Josh once he comes on board in June.
Have a great weekend,
Brian E. Betz, CFP®
Principal
The Dark Cloud Hovering Over The Stock Market
/Market winds may be going through some real change following one of the stranger weeks we have seen in a while.
Just as it looked like stock prices were set to rally, they went backward Thursday and Friday. The S&P 500 index managed to put together back-to-back weekly gains for the first time since mid-February, yet the week ended on a sour note yet again. Here is how crummy Friday has been as of late:
April 20: S&P 500 Down -0.8%
April 13: Down -0.3%
April 6: Down -2.2%
March 30: (Closed for Good Friday)
March 23: Down -2.2%
Normally I would not make much of a couple days, if not for how bonds behaved in light of the late-week stock slide. Bond prices fell in tandem with stocks, which is surprising because often stock market investors pivot over to bonds when they sell stocks. Such was not the case. Both asset classes were broadly negative the past two days.
Should that persist, it spells bad things for the overall market because it means that interest rates are rising while investors see their portfolio values falling. Rising rates are fine when the stock market is stable, but stocks have been fairly volatile for almost three months running now.
One interesting thing to look at is how interest rates have risen over the past two years, specifically short-term rates. In this case, the 1-year Treasury bill. Take a look:
1-year U.S. Treasury bill yield...
Today: 2.22%
1 year ago: 1.01%
2 years ago: 0.54%
Compare this to the more tepid rise in the long-term 10-year bond rate:
10-year U.S. Treasury bond yield...
Today: 2.96%
1 year ago: 2.24%
2 years ago: 1.85%
It is unsurprising that short-term rates have gone up. That is exactly what the Federal Reserve has influenced through a series of rate increases that began in Dec. 2015 and continue to this day. But the fact that long-term interest rates have not risen at the same pace poses the risk we may eventually see an inverted yield curve.
What is the yield curve? The yield curve is pretty straightforward. The longer you lend your money, the greater the interest rate you would expect to receive in return. This creates a rising curve when charting the relationship between time and interest rates. This is normally what occurs most of the time.
For the yield curve to become inverted, longer-term interest rates would have to fall below shorter-term rates. That means investors are paid more for lending their money for shorter periods of time. If that doesn't make sense that is because it is abnormal and the exact opposite of what we want. Using the example above comparing the 10-year Treasury bond to the 1-year Treasury bill, you will notice how that gap has tightened. Two years ago the spread between the two rates was 1.31%. Today it is 0.74%.
Dark clouds forming: An inverted yield curve would be bad because it likely means a recession is coming, as it did prior to each of the past four recessions in 2008, 2001, 1990 and 1981. It can take months or years for the recession to hit after the yield curve inverts, and as we know, stock prices fall first before the economy contracts.
For now this is something to keep an eye on. It is not something to freak out about. A choppy stock market is not a down stock market. It does make our bond market investing more challenging, as conditions have weakened from where they were even a year ago.
In The Market...
The S&P 500 gained +0.5% this past week. Let's look under the hood:
(price data via stockcharts.com)
It might seem weird to read the ominous tone of what I wrote above and then see that most stock sectors were positive on the week. Last week was more a matter of starting strong and finishing weak, which is the opposite of what we want to see if forced to choose. It shows a lack of momentum heading into next week.
Speaking of weakened momentum, the below chart illustrates this concept well. I often say that what makes a positive trend is a series of "higher-highs" and what makes a negative trend is a series of "lower-lows". Notice how the S&P 500 has again peaked at a lower-high since hitting its all-time high back in late-January (the blue trend-line reflects this):
(chart created in stockcharts.com)
If the S&P 500 falls in the coming days and eventually breaks below its 200-day moving average (roughly 2.5% away) that would be very troublesome. We will respond accordingly if that occurs, but for now the market looks like it will continue moving sideways.
In Our Portfolios...
In Financial Planning...
A common feeling right now is a desire to invest more aggressively. This is to be expected when the stock market (up until February) consistently rises month after month. With that in mind, if you want to be more aggressive you need to ask yourself why...
Is it because your financial situation has significantly improved?
Is it because you feel your risk tolerance has been too conservative?
Is it because someone you trust said you should?
Is it because you simply feel like you should be making more?
Some reasons are more legitimate than others. If your finances have improved then it may very well make sense to get more aggressive. But if you have some fear that you are missing out, yet your financial position has not changed, it does not make sense.
The opposite is true too. If you feel you should invest more conservatively, is that because your financial situation has worsened or because you are simply nervous that the market will crash? The former reason is more valid than the latter.
This is where having a plan and sticking to it comes in. Those who do not plan often end up buying at the market top and selling at the bottom. I am happy to revisit your risk tolerance and portfolio allocations -- both on accounts we directly manage and those we don't. Just let me know.
What's New With Us?
I will be working over the weekend and hoping to finally clean our deck, weather permitting. As a heads up, I will be out of the office on vacation Monday, April 30th until Thursday May 3rd. I will periodically be available those days, but just know that I may not be as responsive as normal.
Enjoy your weekend,
Brian E Betz, CFP®
Principal
Does The Lowest Unemployment Rate In 16 Years Make For A Healthy Stock Market?
/In The News...
The last time the unemployment rate was this low I was still a month away from graduating high school...
Unemployment fell to 4.3% in May, the best since May 2001. Here is how rare that is looking back 40 years:
(chart created via stockcharts.com)
Good news, right? Sure. Now take a look at the same exact chart, but with stock market movement plotted on top of it (S&P 500 index, green line):
(chart created via stockcharts.com)
Notice that stocks plunged roughly 1 year from when unemployment fell to levels similar as we see today (the shaded timeframes). As with most charts I share, I created this one. There is also a reason I did.
I am not sure I believe it.
It is not that I do not think the market could fall, it is that I do not believe a potential market drop would be because of unemployment. Correlation does not equal causation. In fact, I could shift those shaded regions forward in time just a bit and argue that the market's declines in late-2000 and late-2007 were what caused the unemployment rate to go up.
The latter is what I actually believe.
I bring this up because I read/hear a lot about how the economy is going to send the market lower. I believe it is the other way around, if it were to happen. This is how I believe it works:
- Shareholders aggressively sell a company's stock (for whatever reason)
- A lower share price means the company is worth less
- Companies whose values fall are forced to cut costs
- The biggest expense for most companies is personnel, which means layoffs
- Repeat steps 1-4 across enough companies and, eventually, economic production falls and unemployment rises
- If GDP - the total output of goods and services in society - is negative for two-straight quarters, it is deemed an economic recession
That is how it works, or at least I think so. Do stock prices fall after companies announce layoffs? Absolutely. But most often those company stock prices have already been in decline. Two recent examples of this are Macy's and GoPro. You think their share prices plunged after a particular layoff announcement? Go look at their stock prices before then. Not good.
What to make of low unemployment: I would be lying if I said I was not paying attention. But it does not influence our investment decisions. When unemployment reached similar lows back in 2000 and 2007 stocks continued to rise for the better part of a year before any major decline. Today, stocks continue to rise to new highs, which is bullish.
They did it again: A bit to my surprise, the Federal Reserve raised interest rates for the second time in three months. I did not think this one would come so soon, but the Fed has done a good job of telegraphing its moves so it isn't a shock based on their previous clues.
This is significant in that it reflects the Fed's view of a more stable economy, namely with regards to hiring and inflation. This was the fourth time the Fed has increased its benchmark federal funds rate since it began doing so a year and a half ago. Here is a brief history of those rate hikes:
- Dec 2015: Up from 0.00% to 0.25%
- Dec 2016: Up from 0.25% to 0.50%
- March 2017: Up from 0.50% to 0.75%
- June 2017: Up from 0.75% to 1.00%
Despite its critics, the Fed has done what it said it would do, which is to gradually raise short-term interest rates as hiring improves and inflation steadies. I highly doubt there will be a third rate hike this year, but we shall see.
In The Market...
The S&P 500 rose +0.3% this past week. Let's look under the hood...
(price data from Yahoo Finance)
Stocks: Two weeks ago I referenced how I felt the Health Care sector might be on the verge of breaking out. Two weeks later, it looks like we might be getting just that. Health Care was the runaway winner this past week, up +3.6%. Take a look:
(chart created via stockcharts.com)
We purchased this Health Care fund (XLV) for most accounts early this past week. It is nice to see its price move higher and our analysis prove accurate. I normally refrain from citing such short-term periods, because typically a few days is not indicative of what is to come. In this case though it might be telling considering our prior analysis. Health Care appears to be roughly where the overall market was back in November -- just about to rally following over a year of stagnation. If this is the case, Health Care has room to run. No guarantees.
Bonds: Treasury bonds continued their ascent and long-term interest rates fell closer to pre-election lows. Investment-grade bonds similarly gained for the second-straight week while high-yield bonds were essentially flat. I remain bullish on the bond market, as I have for the past month or so.
In Our Opinion...
A client told me this week that they sold their shares of Tesla (TSLA). From here there are three possible future outcomes:
- Tesla stock goes up
- Tesla stock goes down
- Tesla stock goes flat
It is natural to second-guess a decision as time passes. I cannot tell you how many times I have heard someone say, "I wish I had not sold my Amazon stock!" or whatever stock that they sold for a gain but did so prematurely, in hindsight, because the share price went on to make new highs.
We have a tendency to look back on decisions like this to attain validation. If the share price falls after selling we feel validated, almost empowered. If it rises post-sale we feel regret. This behavior is instinctual. It is the same reason we check Zillow or Redfin to see what our house is worth. We want to get the best deal and make the right decisions.
Social media has magnified this too. It has fostered a culture where you can easily see the decisions others make and benchmark yours to theirs. But why? Worrying about the past does little good. If you learn something tangible from it that you can apply in the future, great. Otherwise, it is toxic. When it comes to investments, a few key tenets to remember:
- You cannot change the past. Learn if you can and move on.
- You can always repurchase the stock or fund you sold.
- There is an ocean of investment opportunity out there. Whether you make 10% off shares of Tesla or 10% off shares of Proctor & Gamble, what difference does it make? Unless you work for the company and benefit in other ways, the stocks or funds you own are just names on a statement.
- Just because someone else bought or sold something does not mean you should too.
In my years of doing this, I remove as much emotion from our investment process as possible. I try to stick to that process, no matter what, though I do try to refine it and improve it over time. In the same way I do not dwell on what might be perceived as mistakes made, I do not celebrate the wins, either.
In Our Portfolios...
(Note: Each client's account is uniquely managed, based on account size and risk tolerance. Your account will only own some, not all, of the investments bought and sold over time.)
Q&A/Financial Planning...
An annuity provider sent me an article last week entitled: "Have Indexed Annuities Become Too Complicated?"
I believe this is old news, which is easy for me to say being so entrenched in the financial services industry. So I can see how this might be news. In short, yes they have.
Annuities are a source of income for those who need a specific amount of money for a specific period of time in retirement. It is like creating a pension for yourself, except with your own money. The two main types of annuities are immediate and deferred.
Immediate annuity: You put up a chunk of money today in exchange for a stream of income that starts now. That stream of income could last your entire life, the collective lives of you and your spouse, a set number of years, etc. The longer your timeline, the smaller the annual payments.
Deferred annuity: You put up a chunk of money today, but your income stream does not begin until a point in the future (often 5 years, 7 years or 10 years later). While your money is committed, it ideally grows based on some investment strategy. The growth could be fixed (e.g. guaranteed 4% per-year) or it could vary (e.g. tied to the stock market). This is where it gets complicated, as investors seek for ways to grow their savings in the years just preceding retirement.
Once upon a time, certain annuities had appeal, particularly a hybrid known as "indexed" annuities. These became popular in the wake of the 2008 recession. Indexed annuities provide the ability to earn up to a certain amount, or "capped" return, which is tied to the performance of a particular index (typically the S&P 500). In exchange for having a cap on the potential gain each year, you are guaranteed against loss. The latter having big appeal following the financial crisis.
Indexed annuities were en vogue as investors wanted to invest but could not stomach any risk of loss. Because these annuities are not technically invested in the market - rather, credited interest based on market performance - they have been deemed insurance products. As popularity grew, more and more insurance companies created their own flavor of indexed annuity in an attempt to provide one more feature than the next. And because there are far more insurance reps than there are professional money managers, these annuities have had great distribution.
Today, most indexed annuities I see are over-engineered. Their multi-page brochures are chock-full of confusing terms, a multitude of hypothetical scenarios explaining how the annuity might perform and a ton of fine print that often buries key restrictions. It would take me an hour to fully understand the product and another two hours to properly explain it to you. That may be a bit overstated, but the point is, if I cannot easily understand an investment how could I expect you to?
Annuities, by and large, have a place for certain retirees who want to live off a known, fixed income. But they also face many headwinds. Just a few of them...
- They can carry heavy commissions that are often concealed and go unknown until after you get the annuity, when it is too late
- The market has a natural bias to rise over time. So while indexed annuities might look great coming off 2002 (tech bubble burst) or 2008 (financial crisis), what about all those non-recessionary years?
- A lot of insurance reps (and annuity providers!) do not understand the annuities they sell. This often leads to clients making bad financial decisions, whether the insurance rep was intentionally misleading or just naive/uneducated.
- If you change your mind, you will pay a sizable "surrender charge" to reclaim your money. This makes buyer's remorse costly. (In fairness, the surrender charge on a deferred annuity does typically go down over time.)
- Most annuity owners do not need an annuity, they need proper financial planning that determines how they will generate retirement income and avoid running out of money. Oftentimes annuities provide an adequate solution for this, but not the best solution.
Whether an annuity is immediate, deferred, fixed, variable or indexed, it can have its place for the right type of client. But you must cut through the confusion to fully understand how it functions, the restrictions involved and how it ultimately fits you better than the next-best alternative.
What's New With Us?
I will be traveling to Ohio to visit family all of next week. It will be business as usual, working remotely, but my response time may not be as quick while I am away. I return on Monday, July 3rd. I hope your summer is starting out well!
Have a great weekend,
Brian E Betz, CFP®
Principal