It’s been a surprisingly good year for the markets.
The strength of the consumer is at an all-time high, and the U.S. unemployment rate dropped to a historic low. Vice President of Willis Johnson & Associates, Nick Johnson, CFA®, CFP®, offered an analysis on the state of the market going into Q3 in our quarterly market update.
Recent Market Performance
April – June 2019
- • Especially after last year, when the market was down 4.5% for Large Caps, Small Caps were worse, and Internationals were horrible.
- • REITs (real estate) have been the best performers in 2019 with 19.3% by the end of June in the S&P500, followed by Large Caps at 18.5% and Small Caps just behind them.
- • The U.S. has outperformed Internationals. Brexit and trade could have major impacts on International performance later this year, but it’s still too early to be certain.
- • Fixed Income has also had a decent year — High Yield bonds are up 9.5%, Fixed Income is at 6.1%, Commodities are at 5.1%, and Cash for the first six months is only at 1.2%, barely keeping up with inflation.
- • The US consumer is in really good shape– Household net worth is at all-time highs. At 9.9%, the Debt Service ratio is near all-time lows.
- • The low debt service ratio is good for the economy because consumers can either purchase goods or invest.
GDP & Unemployment
- • The consumer in the U.S. makes up about two-thirds of our GDP through consumption.
- • Only 17.1% of GDP is from government spending. 14.4% is from Investment Ex-Housing, 3.8% comes from housing and Imports/Exports actually hurt our GDP because we import more than we export– so it’s -2.9%.
- • Many analysts think that we’re on track for a 1-1.5% GDP growth, which, is a slow GDP growth rate during an expansion period.
- • Wage growth is up 3.4%, and our unemployment rate is at historic lows– 3.7 % unemployment whereas the 50-year average is 6.2%.
US Market Evaluation
Are we overdue for a recession? What’s behind U.S. earnings growth?
- • It’s been 120 months, 10 years, since the last recession, which makes this one of the longest expansion periods to date.
- • Bull markets never die of old age. In periods of time when you have faster economic growth and you can see a higher GDP growth rate, here’s where you tend to have bubbles and bursts happen sooner together from the last expansion to the next recession. Things are growing faster, so you tend to get bubble time periods and quick bursts. If you’re having slower economic growth, which is what we’ve been having, expansions tend to have long periods of time to expand before you get bubbles that then burst.
- • From the bottom of the market in 2009 through the end of June, the S&P grew 335%. Today, the price to earnings ratio is 16.7%, so you’re paying 16.7 times every dollar’s worth of earnings.
- • When interest rates are low, you naturally can have a higher price to earnings ratio because there aren’t really other options to invest. If you’re not getting paid anything on a fixed income and you’re not getting paid anything on cash, equities are the only game in town, so naturally, price-to-earnings ratios can be a bit higher.
International Equities & Global Trade
- • Coming out of the last recession, U.S. equities are up 335%, Internationals are up 112%.
- • Internationals have a forward P/E (the price you’re paying per every dollar of earnings) of 13.2. You’re underneath the 20-year average, while U.S. equities are slightly above the 20-year average.
- • We’ve had a strengthening dollar, and from a US investor’s perspective, that hurts International returns. It’s the local currency return + the currency return = the U.S. dollar returns if you’re investing in Internationals.
- • Trump’s now pushing for a weakening dollar, and we’re talking about potentially lowering rates this year on the Federal Reserve Banks instead of raising them. If we have a weakening dollar, that could be helping International returns going forward.
- • We’ve had a slowdown in global manufacturing according to the Global Manufacturing Index primarily driven by trade.
- • Trade wars, even if a lot of it is just talk, are really hurting the markets here. Global tariffs overall aren’t that high– Currently right around 4.5% in global tariffs on the U.S. side. World Trade is shrinking and exporting countries are being hurt the most. Generally, we’re seeing exporting countries being hurt more than the US, but even we’re also being hurt by trade wars.
Fed Policies, the Yield Curve, and Fixed Income
- • Big picture: we think it’s very likely the Fed drops rates once, if not twice this year into next year, which is going to be potentially good for certain areas of fixed income and good for the market, but it makes us question the long-term health of the economy.
- • Why is the Fed cutting rates? Generally, when it appears that a market is overheating (where you’re at full employment, wages are growing, and you’re starting to get too much inflation) the historical playbook and monetary policy say you raise interest rates so the market doesn’t overheat and drive you to recession too quickly.
- • Since the fiscal policy is tightening things up, and since trade is slowing down global growth, the Fed may not offer an accommodative monetary policy to offset that.
- • The yield curve is currently inverted meaning some short-term rates are above medium-term rates and some long-term rates. A yield curve inversion does not always predate a recession.
Projections & Considerations
- • Right now, cash real returns are almost negative, so you’re not getting much value being in cash today.
- • We think equity returns are likely to be in the mid-single digits going forward on average. If we take a rolling three-year or a rolling five-year, returns will likely rise to mid to high single digits. We’re not going to see double-digit returns like we’ve seen the last five years due to valuations where they’re at today and where we’re at in the economic cycle.
- • If you’re not a long-term investor, and you’re not going to stick with it, you shouldn’t be investing as aggressively. The average investor over the last 20 years, on average has returns of 1.9%. That’s worse than inflation, homes, Internationals, fixed income, or the S&P 500. So, it’s really important as you’re setting an asset allocation for yourself to be working with a professional.
If you want a second opinion about your investment strategy and how it can affect your long-term financial plan, schedule a conversation with a Willis Johnson & Associates financial professional to learn more about what you should consider.
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