Over the last five years, stock prices for the S&P 500 have gained more than 50%. Meanwhile, after-tax profits at non-financial companies have actually declined in the period. Is that sustainable?
Credit the Fed for its QE-inspired wealth effect.
Some believe that the Fed stopped QE when they halted purchases with the creation of new electronic credits at the end of October 2014. However, a more nuanced explanation is that the Fed maintained QE levels above $4 trillion straight through the start of 2018. Maintaining an elevated balance sheet with the aid of trillions of reinvested dollar credits is still QE.
There was a small amount of tapering in 2017. Yet that was offset by corporate tax reform stimulus. In 2018, the Fed attempted to reduce its balance sheet in earnest. Then the S&P 500 fell 19.9% in Q4.
What did the central bank of the U.S. do to resurrect the wealth effect? It completely flip-flopped on everything from interest rates to what it should do with its balance sheet.
Instead of raising rates four times in 2019, they slashed rates three times. And, not surprisingly, the Fed’s “funny money” balance sheet has puffed back up to $4.1 trillion.
Without a doubt, the Fed’s easy money liquidity has been the driver for 2019’s stock market recovery and subsequent record highs. Profits? Earnings per share (EPS) actually decreased in 2019.
Granted, there have been stretches in history when financial markets disregard profit trends. When it has happened, though, stock valuations became bubbly.
Objective measures for asset price valuations — price-to earnings (P/E), P/E 10, market-cap-to-GDP, price-to-sales, Q Ratio, regression-to-trend — have been pointing to extremely overvalued conditions for years. Circumstances may not be as fizzy as they were in the year 2000, though they are frothier than they were in 1929 and 2008.
The uninformed response to the data is that traditional valuations do not account for “ultra-low” interest rates. On the other hand, one can easily debunk the myth that low interest rates alone justify extreme valuations.
Consider the fact that the U.S. experienced a similar low interest rate regime for 20 years from 1935-1954. Traditional valuation metrics did not reach the extraordinary heights of 1929, 2000, 2008 or 2019 during the 20-year period from 1935-1954. (See the chart above.)
There’s more.
Economic growth was far greater during the 1935-1954 period than it has been in this decade. Nevertheless, the ultra-low rates in those years still did not derail bear markets from occurring in 1937-1938 (-49.1%), 1938-1939 (-23.3%), 1939-1942 (-40.4%), or 1946-1947 (-23.2%).
Investors need to see the current environment for what it is — a QE-fueled wealth effect.
Think about it. How does the Fed hope to stimulate job growth and achieve stable inflationary targets? The members of its voting committee look to push up asset prices to make consumers and businesses feel wealthier and, subsequently, spend money.
Businesses did some spending, of course. Yet less had been allocated to human resources and capital expenditures than to stock buybacks. Now those corporations have some of the worst debt ratios in their history.
Consumers have been the true saviors. They still have jobs, so they keep on spending.
Still, the signs that consumers may spend less are evident. Job growth is waning, year-over-year retail sales are slowing and expectations about the economic future are falling. In fact, the gap between present circumstances and future expectations is worse than it was in 2008 and nearly as bad as it was in 2000.
If the economy stagnates, or if the bond market sniffs out ongoing weakness, the Fed will continue to increase its balance sheet and cut overnight lending rates even more. Voting members have no other plan.
Many wonder what the catalyst for a wealth effect reversal might be. Yet a catalyst may not be easily identifiable and it may not be singular.
Keep in mind, there is no agreed-upon catalyst for the bursting of 2000’s tech bubble. The Fed was too loose with policy in the late 1990s? Then hiked rates too far? Then cut too slowly? That’s part of the story.
It follows that a combination of factors can come together to produce a rapid unwinding. Here are a handful of potential contributors (in no particular order):
1. Fed Policy Error. Asset prices may fall because the markets become dissatisfied with the pace of QE or the amount of QE or any other aspect of policy (e.g., rates, forward guidance, inadequacy of a new tool, etc.).
2. Market Uneasiness Over Unsustainable Borrowing Cost Path. Clear across the world, inflation-adjusted interest rates are negative. That which led to over-borrowing could serve as a direct or indirect catalyst, particularly as it relates to the possibility of a fallout from a downgrading of BBB-rated corporates and/or a crisis in the leveraged loan arena.
3. Fewer and Fewer Share Buybacks. Corporations borrowed by the boat load to shovel the money back into their stock shares. That support is already slowing, with share buybacks 30% lower in 2019 than in 2018.
4. Complete Loss of Faith in Global Trade. The global manufacturing recession may become contagious. Tariff removal and trade deals may come along too late, or never amount to anything meaningful. Four consecutive ISM readings below 50 raises the risk of a pile-up in layoffs.
5. A 4.1% U-2 Unemployment Rate. “Are you nuts, Gary? 4.1% is remarkably low in the history of this country.” That may be true, yet it also represents a 0.5% rise above the cyclical low of 3.6%. Every recession since 1970 occurred when the three-month average unemployment rate rose at least 0.5% from its 12-month low.
None of the aforementioned contributors have occurred… yet. Any or all of them could occur in 2020.
One of the ways that an investor can still participate in market upside with less fear about a bearish wipe-out is with a “Defined Outcome ETF.” For example, December’s incarnation of the Innovator S&P 500 Power Buffer ETF (PDEC) seeks to track the return of the S&P 500 Price Return Index up to 8.92% (12/04/19) at a price of 26.33, while buffering investors against 14.56% of losses through 11/30/2020.
Income-oriented investors may be more inclined to stick with dividend aristocrats that have raised their dividends for 40-plus years. Talk about reliability through thin and thick!
Johnson & Johnson (JNJ), PepsiCo (PEP) and Clorox (CLX) “screen” more favorably than others. That said, none of them are inherently cheap.
Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.
]]>For example, one may hear that the job market is strong. Yet job growth and job openings are both fading.
One may be told that the consumer is spending. On the other hand, year-over-year retail sales (2.88%) are well below last year (4.58%).
In a similar vein, The Bloomberg Consumer Comfort Index fell to a nine-month low of 58. The measure even posted its steepest three-week slide since 2008.
Meanwhile, manufacturing remains mired in an outright slump. The most recent data on industrial production came in at a three and a half year low.
There’s a straightforward reason why the Federal Reserve cut its overnight lending rate three consecutive times. It did so because the economy is shaky.
Would Fed committee members be looking to provide monetary stimulus if prospects were wonderful? Keep in mind, the Fed is projecting fourth quarter economic growth at just 0.4%.
Corporations are hardly bucking the economic trend. Earnings have been negative for three consecutive quarters. It is likely to be negative for all of 2019.
Equally disturbing? CEO confidence has slipped to levels that preceded the prior four recessions.
Why, then, is the stock market breaking higher? With six straight weeks of upward movement? Massive inflows of central bank liquidity.
Just one year ago, stocks were free-falling. It was happening because the Fed had planned to hike rates throughout 2019 and had intended to reduce the size of its balance sheet (a.k.a. “quantitative tightening” or “QT”) into 2020.
Instead, overnight lending rates were slashed in 2019. And when that did not satisfy financial market participants, the Fed began pumping hundreds of billions back into the system (a.k.a. “quantitative easing” or “QE”). Stocks have been rocking ever since!
With the Fed throwing monetary spaghetti at the “Wall,” nobody wants to be caught short. Consider the CBOE Equity Put Call Ratio. According to Dana Lyons, the measure just registered one of its lowest readings (<0.50) in a half-decade.
Other signs of giddiness? Investors Intelligence reported advisory sentiment at 57% bulls versus 18% bears. And Citi’s Greed Fear Index recently moved into “extreme greed” territory.
Historically speaking, irrational stock market enthusiasm has been a time to reduce risk, not take substantially more of it. The best time to embrace risk with everything you’ve got? When there is panic and hopelessness.
Is this time different? After all, the Fed’s injections of liquidity have trumped the need for corporations to increase their profits. In many instances, profitless corporations without a path to profitability have still seen their shares soar.
The price one pays for bottom line earnings has become irrelevant. What about revenue? The price one pays for corporate sales is as insane as it was during the turn-of-the century stock bubble.
Some of us remember when Warren Buffett described market cap to GDP as the best indicator of whether stocks are overvalued or undervalued. In the era of QE, though, valuation has been little more than a quaint concept.
What will happen when over-leveraged, profit-challenged corporations struggle to generate business and scramble to pay debts? Companies will freeze hiring and, eventually, announce layoffs.
It may not happen all at once in crisis-like fashion. Still, employees and independent contractors will become concerned about their pay and consume less.
Investors may need to ask themselves, will the Fed have enough ammunition to prevent the economy from stagnating? From shrinking? Can their actions prop up stocks indefinitely, or is it more plausible that a “wealth effect reversal” occurs in spite of monetary policy magic?
Many agree with the notion that the Fed has created a super-sized asset balloon. On the flip side, some of these folks cannot see a pin prick in their front-view windshields.
It follows that they’re not inclined to ratchet down their exposure to risk assets. Instead, they think they can get out before a mad rush for the exits.
Some will. Some won’t.
I would argue that it does not matter what pops the balloon to lead to the next bear in stocks. It could be a loss of faith in foreign central banks or a loss of faith in Federal Reserve policy (e.g., too little QE, too much QE, too slow with stimulus, too fast with stimulus, etc.). It could be an unwinding of leverage from the leveraged loan arena to margin debt to BBB-rated corporate downgrades. It could be a sharp shift away from stock buybacks. It could be a chain reaction of negative sentiment surrounding “unicorns.”
It could be almost anything. And in all likelihood, it will be identified in hindsight.
Identifying the pin or pins beforehand is less critical than having a plan for a dangerous downturn. That plan should incorporate hedging one’s exposure to common stock as well as reducing one’s exposure.
The most effective hedges tend to be a combination of the highest “quality” government bonds, precious metals like gold and currencies like the dollar. ETFs like iShares 20+ Year Treasury Bond (TLT), iShares 7-10 Year Treasury Bond (IEF), SPDR Gold Shares (GLD) and Invesco DB Dollar Bullish (UUP) provided non-correlation with U.S. stocks and protection against capital depreciation in 2008.
If you are concerned that hedging alone won’t do the trick, consider Pacer’s Trendpilot US Large Cap ETF (PTLC). It participates in technical market uptrends while systematically shifting to T-bills if technical trends turn down.
Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.
]]>Just how “easy” is the Fed’s monetary policy? The real Fed Funds Rate (FFR) is at -0.8% right now. The last time the inflation-adjusted FFR was down at -0.8% had been 8-9 months into the Great Recession (10/2008). Before that, the country had been 8-9 months into the 2001 recession (12/2001).
Pushing the cost of capital to insanely cheap places used to be a tool for alleviating recessionary pressure. Today? The central bank of the United States believes in the permanence of cheap credit to maintain elevated levels of stock, bond and real estate prices.
The proof of financialization is in the bread pudding. Never in the history of the U.S. economy has the ratio of household assets to nominal gross domestic product (GDP) reached 4.25.
It’s not just the reality that asset price inflation is vital to economic well-being in 2019. Previous wealth effect reversals occurred because of an over-reliance on respective asset bubbles in stocks in 2000 and real estate in 2008. (See the orange lines in the chart above.)
Unfortunately, most of the Federal Reserve committee members only see the “benefits” of the present-day wealth effect. Few of them show any concern about the eventuality of an ugly reversal.
Never mind the probability that the Fed will not have enough ammunition for a crisis or recession. All-star economists are notoriously poor at alerting folks when a recession is happening. In particular, the average number of months between the inception of economic contraction and a pronouncement by the National Bureau of Economic Research (NBER)? 9 months.
Granted, people keep on spending in ways that is keeping the current expansion alive. Indeed, the recent 1.9% GDP print was entirely attributable to the resilience of the consumer.
On the flip side, consumers have rarely been as pessimistic about the economic future. The difference between present day circumstances and future expectations are nearly as bleak as they were leading into the 2001 recession. They are even more stark than they were leading into the Great Recession of 2008.
Businesses are already glum. A broad measure of job gains in a survey by the National Association for Business Economics (NABE) is at its lowest level since 2012. Meanwhile, according to Jon Hill at BMO Capital, CEO confidence hasn’t been this low without the economy entering recession or already mired in one.
Small companies may be struggling the most. The proportion of non-earners within the Russell 2000 is getting closer and closer to 30%. Jill Carey Hall at Bank of America Merrill Lynch points out that these levels are usually seen during economic downturns.
Of course, none of the troubling specifics imply immediate doom for stocks, corporate bonds, real estate or other risk assets. Chairman of the Fed, Jay Powell, has been keeping the asset price dream alive with three consecutive rate cuts and $60B-plus in monthly treasury bill purchases — a quantitative easing (QE) elixir where the electronic dollar credits eventually find their way into riskier investments.
Think about it. Not only is the FFR stimulus as accommodating as it was during the 2001 recession as well as the Great Recession in 2008, but the Fed’s balance sheet is now back above $4 trillion. (They just keep right on cranking the electronic money printing press!)
Perhaps ironically, capital spending at corporations continues to weaken and earnings continue to slide. It follows that wildly optimistic earnings estimates for 2020 will need to be slashed, pressuring valuations. And those valuations are already pricey.
Can Fed actions and the actions of other major central banks (e.g., European Central Bank, People’s Bank of China, etc.) really keep U.S. asset prices elevated indefinitely? In spite of late cycle indications? Many in the financial media seem to think so.
However, it is more likely that a shock to the system will trigger a wealth effect reversal. And with it, another recession.
Until that time, though, investors still need to allocate a percentage of their assets to equities. Here are three ways that one may do so, even if the stock bull is close to meeting its maker:
1. Defined Outcome ETFs. Would you willingly cap your upside in the S&P 500 over the next 12 months if it meant you would not experience any losses on the first 15% of a market sell-off? The Innovator S&P 500 Power Buffer ETF (PNOV) seeks to track the return of the S&P 500 Price Return Index up to 8.75% (10/31/19), while buffering investors against the first 15% of losses over the next year (11/1/19-10/31/20).
The cap and the buffer have already changed from PNOV’s inception. At the moment (11/4/2019), with stocks gaining ground on 11/1 and 11/4, the cap is 8% and the buffer is 15.5%. The downside before the buffer would kick in is -0.72%.
2. Trend ETFs. Some folks would prefer to capture all of the market’s upside potential. After all, who knows how “bubblicious” equity indexes will get in the year ahead. Still, is there a mechanism for protecting gains or limiting losses within an equity investment itself?
Enter Pacer’s Trendpilot US Large Cap ETF (PTLC). As long as the market is trending higher, you’re in there. Should a short-term market downtrend develop, PTLC pares back some of its equity exposure. And if the market signals a longer-term downtrend? PTLC shifts its allocation to the safety of treasury bills.
I am a fan of paying attention to technical trends. Long-time readers know that I am particularly fond of the slope of the S&P 500’s 10-month simple moving average (SMA) as well as its monthly close. The monthly close on the 10-month SMA helped me sidestep the bulk of the carnage in 2000 as well as 2008.
3. Value ETFs/Dividend Aristocrat ETFs. It’s not that value stocks and dividend aristocrat stocks represent bona fide bargains; rather, they are relative bargains to the growth stock bonanza that has characterized this decade.
If you’re like me, and you think that the Fed will not be able to override the business cycle altogether, then you might appreciate the SPDR S&P Dividend ETF (SDY) for tracking the total return performance of the S&P High Yield Dividend Aristocrats Index. (The “aristocrats” in this index have a 20-year track record of consecutive dividend increases.)
From a technical perspective, the SPDR S&P Dividend ETF (SDY):Nasdaq 100 (QQQ) price ratio is showing a “bottoming process” for SDY. Going forward, SDY is likely to outperform.
Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.
]]>Consider homebuyers. Mortgage rates are dramatically lower than they were a year ago. Regardless, the median new home sales price has had to drop significantly to entice fresh borrowing.
At some point, consumers and businesses may choose to avoid more debt altogether. It simply won’t matter how cheap the cost of capital becomes. (That’s what transpires during a recession.)
In truth, we’ve already seen the ill-effects of negative rate policy in Europe and Japan. Ex U.S. businesses have not taken the bait. The unwillingness of ex U.S. companies to borrow in the debt markets for the purpose of buying back stock shares partially explains why a global bear has persisted since January of 2018.
Since January 2018, ex U.S. stocks have yet to recover and remain down more than 10% from highs. Meanwhile, even small stocks in the U.S. Russell 2000 Index are negative over one year and nine months.
Granted, the S&P 500 may have gained close to 5% in a market-cap weighted capacity. Nevertheless, one would have done better over the past 21 months with 100% in “risk-free” intermediate-term U.S. Treasuries via iShares 7-10 Year Treasury Bond (IEF).
From an individual sector standpoint, U.S. financials, industrials, materials and energy are negative since January 2018 as well. That has a lot to do with the worldwide manufacturing slowdown.
“But Gary,” some say. “U.S. stocks have been remarkably resilient, and they’re poised to break out to all-time record highs.” Maybe.
Naturally, stocks could pop on trade deals. For that matter, economic growth around the world could make a comeback. Yet this remains in the category of “hope,” and it certainly does not constitute an investment strategy.
On the flip side, just how much Federal Reserve manipulation has been necessary to avoid a wealth effect reversal? First, we went from rate hikes to rate neutrality at the start of 2019, augmented by an end date on quantitative tightening (QT). Less than six months later, Jerome Powell, chairman of the Fed, began promising rate cuts.
Not only did we get rate cut 1, and rate cut 2. We’re getting a third one here in October.
But wait. There’s more. The Fed started a massive QE4 program to acquire treasury bills so that more liquidity would end up in risk assets.
Talk about monetary policy stimulus! The Fed has increased its balance sheet by $200 billion in the last month alone!
It’s not difficult to see why financial assets of all stripes are hanging in there. “Money” continues to make its way into risk.
What is more difficult to see is the other side of this equation. Specifically, with everything from trillions in government deficit spending to corporate stock buybacks to mountainous levels of Fed stimulus, why has the U.S. stock market barely made progress since January of 2018?
The answer may not be as straightforward as one would like. Recession fears. Political uncertainty. Geopolitical strife.
That said, those who I speak with in and around “Wall Street” currently fret about the strong prospect of an Elizabeth Warren agenda. What’s more, scores of candidates on the Democrat side of the aisle openly discuss unraveling Trump administration policies, from deregulation to corporate tax cuts.
In other words, monetary policy may be a phenomenal driver for asset prices. But the threat of monumental changes at the fiscal level could be a straw that breaks the asset camel’s back. (Note: This is not political commentary, but rather, a discussion of “possible” stock and bond market ramifications.)
Nobody knows who will control the U.S. Congress. Or for that matter, who will will win the presidential election in 2020.
Still, I am willing to make a relatively bold prediction. With the Fed’s increasingly aggressive intentions, alongside recessionary concerns and an uncertain election, the U.S. 10-year yield will fall below 1%.
75 basis points and a modicum of yield might not seem like it will produce an extraordinary total return. Maybe we are talking about 5%-7% on iShares 7-10 Year Treasuries (IEF).
Then again, I do not have the same confidence that, prior to the outcome of the 2020 decision(s), U.S. stocks will hold at levels that are 5%-10% higher than they are today. Even if they go up 10% to close out to 2019, they’d likely be reined back in before October 24th of 2020.
It is true that Federal Reserve QE has been incredible in boosting risk assets in the past. However, I am not a believer in the notion that the Fed has repealed the business cycle. As I wrote earlier, there comes a time when the Fed won’t be able to force credit on those who choose to refuse it.
Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.
]]>Some believe that the growth does not need to end. Ever. They quip, “Economic expansions don’t die of old age.”
Others wonder if the business cycle will end soon. After all, every decade on record has experienced at least one recession.
The problem with focusing on when the next recession will occur? It assumes that asset prices decline dramatically because an economy shrinks. That has not been the case in the 21st century.
Here in the 21st century, causation has been turned on its head. Recessions did not cause stocks, bonds and real estate to get crushed; rather, asset price decimation caused the recessions that transpired.
Consider the 2001 recession. It came about due to the bursting of the tech bubble in March of 2000. Severe stock price depreciation, particularly in dot-com names, led to the layoff of millions of employees and to a painful pullback in consumer spending. Indeed, a vicious bear had been clobbering stocks for a full year prior to the 2001 recession.
What about the Great Recession (12/2007-5-2009)? The housing bubble actually burst in the first quarter of 2007, 10 months prior to the December time stamp. What’s more, it wasn’t until late in the 3rd quarter of 2008 that recessionary pressures were being acknowledged.
Voting members of the Federal Reserve understand this 21st century dynamic. Not surprisingly, then, committee members will do whatever it takes to keep asset prices afloat.
Most recently, the Fed began “QE4.” Nobody wants to call it that. Yet when a central bank creates trillions of electronic dollar credits out of thin air to buy assets, and never gets rid of those credits, the central bank has engaged in electronic money printing.
The Federal Reserve is purchasing $60 billion a month in securities from the open market. That’s as much quantitative easing (QE) as what occurred during the financial crisis in 2008. The question people should be asking is what emergency currently exists such that the Fed needs a new program of asset purchasing straight through the 2nd quarter of 2020?
The Fed wants the new “money” to wind up in stocks, bonds and real estate. That is how they hope to extend the longest expansion in history. Never mind the fact that manipulating interest rates lower makes it possible for consumers, businesses and governments to borrow for even less.
What could possibly go wrong?
There are those who maintain that the Fed is being sensible. Yet they’re ignoring the adverse impact on future returns for bond holders and savers. Even worse? When short-, medium- and long-term rates are as depressed as they are, retirees and near-retirees feel coerced into taking on larger risks to meet needs.
What about the future return prospects for equities? At current valuation levels, the next decade could offer a whole lot of risk and not much in the way of gain.
There’s more. Corporate earnings will likely shrink for a third consecutive quarter. That could make stock valuations even foamier.
It is also worth remembering that large-cap U.S. stock enthusiasm is not matched by smaller companies. The Russell 2000 Small Cap Index has been in a rut for over a year. In fact, prices are 12.3% LOWER than they were at their peak in September of 2018.
One explanation? Small business confidence has been dropping precipitously. It recently registered a 7-year low.
Indeed, investors may already be bracing for atrocious losses. Assets with lower perceived risk have been garnering the lion’s share of investment dollars throughout 2019.
If you are nearing retirement, there are no easy answers. A traditional portfolio of stocks and bonds — 60/40, 50/50 — may go nowhere for a decade. Or bearish losses may take the better part of the next 7-10 years to recover.
Dividend income may be reliable from the highest quality names, particularly the “dividend aristocrats.” Yet few folks will be giddy about a 2.5%-3% annual income stream should bear market price losses hit 35%, 40% or 50%. (And can you really count on a 5-year break-even time horizon?)
Despite the fact that rate-sensitive investments (e.g., dividends, REITs, utilities, preferred stock, etc.) are part of a “crowded trade,” I still favor them. I like exchange-traded trackers such as SPDR S&P Dividend ETF (SDY), iShares Core REIT ETF (USRT) and Van Eck Market Vectors Preferred Ex Financials (PFXF).
Nevertheless, I am aware that the positioning is a crowded one and that tactical asset allocation changes will become necessary. “Hope-n-hold-everything” may work for some folks. Others can appreciate the power of losing less in a violent market meltdown.
Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.
]]>Even though the S&P 500 and the Dow did not fall 20% from their January 2018 peak, there has been minimal stock progress across 20 months. The Wilshire 5000 provides clear evidence that the entire U.S. stock market has been trending sideways in much the same way that it did during the 2015-2016 manufacturing recession.
Interestingly enough, we are experiencing yet another manufacturing recession here in 2019. Not only is the ISM’s PMI composite the furthest below the expansion mark (50) since the Great Recession, but new export orders have collapsed altogether.
Bullish stock investors seem to think that there’s little reason to fret. The manufacturing downturn of 2015-2016 had been confined to the energy space and, eventually, stocks rocketed higher.
Lost in the retelling, however, stocks did not rocket skyward until two significant stimulus prospects came into the picture. Trump’s promise of dramatically lower corporate taxes served as a monumental boost in November of 2016, as Republicans took control of both the White House and Congress. Equally important, the European Central Bank (ECB) and others around the globe embarked on their most ambitious quantitative easing (QE) stimulus package(s) to date.
Here in 2019, though, there may not be enough global monetary stimulus or domestic fiscal stimulus available. At least not enough to benefit stocks in a meaningful manner. The Fed is debating one-quarter point reductions in the Fed Funds rate, which is unlikely to do the trick. And the ECB may already be near the end of the line.
The U.S. Fed Funds rate is at 1.75%-2.00%. The 10-year Treasury yield is at 1.60%. Are quarter point cuts by the Fed going to help much when you’re already stuck in an extremely low rate environment? Can the ECB stimulate much in the way of growth when five-plus years of negative interest rate policy and massive QE projects are failing?
In a similar vein, it may become more difficult to justify year-over-year contraction in corporate earnings. In 2015-2016, most of the contraction occurred in Big Energy. This time around? We’re seeing a greater dispersion of negative earnings growth, especially in prominent segments like technology.
Of course, there are those that argue that manufacturing no longer matters because the U.S. is a service-based economy with service-oriented employment. The problem with the assumption that manufacturing has become irrelevant stateside? Goods producing corporations still account for a massive share of the profits in the S&P 500.
Granted, an end to the trade war with China could give a jolt to CEO confidence as well as to the U.S. stock market at large. On the other hand, with the index for New Export Orders (see chart above) all the way down at 41.0, one might want to question whether or not the trade war with China is the only issue. We do not export a whole lot to China and new export orders have nothing to do with tariffs on Chinese products. More likely, the downshift is a reflection of an overall recessionary environment across top economies all around the globe.
It may be true that consumer resilience is a big reason why the S&P 500 remains within striking distance of all-time records. Yet consider the chart below. Historically, when consumers show far more optimism about the present-day economy than future economic conditions, broad-based recessions are rarely far behind.
In truth, defensive U.S. stock positioning has been more sensible than aggressive stock positioning for six months already. Consider the rising price ratio for iShares USA Minimum Volatility (USMV):Invesco S&P 500 High Beta (SPHB). It represents a classic late-stage shift in equity positioning.
Are there things that might delay the arrival of a bearish downturn for risk assets? Sure. At least in the near term.
If the Fed abandons a slow-n-steady approach to monetary stimulus, and announces significantly larger cuts to the Fed Funds rate alongside a form of quantitative easing, investors may be encouraged by a “do whatever it takes” approach. Along those lines, Trump could end tariffs outright and choose to strike some sort of deal, removing the overhang of ongoing uncertainty.
Nevertheless, if a broad-based recession is in the works, neither the “Fed put” nor the “Trump put” is likely to prevent a wealth effect reversal. In fact, a wealth effect reversal may come to fruition regardless, ushering in job losses as well as an economic slump.
It’s not that I am abandoning large-cap indexing altogether. On the contrary. It has still proven safer than foreign equity exposure and small cap stock exposure. Yet I have less than I might otherwise have in an early stage bull.
What’s more, I continue to favor defensive investing areas. “Preferreds” and preferred-stock-like debentures have been very fruitful. Treasuries, A-rated quality corporates, and the occasional convertible bond are all possibilities.
High on my list? Annaly Capital Management Inc 6.95% Series F Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (NLY.PRF). I believe Annaly has been responsibly planning for a late credit cycle well ahead of time. And as I have discussed throughout 2019, VanEck Vectors Preferred Securities ex Financials ETF (PFXF) presents a reasonable risk-reward relationship.
I haven’t backed off the capital appreciation potential in the Treasury bond proxy iShares U.S. Treasury Bond ETF (GOVT) or the A-rated corporate bond tracker iShares Aaa – A Rated Corporate Bond ETF (QLTA). Bonds may be “overvalued” like every other asset in the “Everything Balloon,” but they will gain more ground unless recession fears prove entirely unfounded.
Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.
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