January 2020
Snakes in the Grass
“We have a tortoise-like economy and a hare-like stock market” -Global strategist at JPM
The above quote from Barron’s rings true, thanks in large part to the Federal Reserve’s intention on keeping rates low for the foreseeable future. It made me question again what lies underneath all of this. In sticking with the tortoise vs hare theme, I was reminded of an example from my college days working at the golf-course back near my hometown. One summer afternoon, as I was climbing out of a creek where I had been weed whacking, my head popped above the bank, and I froze. Within an armlength of my face, laid a massive, thick-bodied Copperhead coiled in the long grass. Luckily, he leaped by me and was gone. But this face-to-face encounter with a large, poisonous snake was a frightening reminder on the need to weed-whack that area much sooner the next time.
The point: Do not allow things to become too overgrown. Hidden risks lie in this economy and markets today. There is a need for staying grounded and trimming aggressive positions, much like that creek needed.
Emotional Regulation
Every day we are exposed to a variety of emotional stimulus, including feelings about our own money. Disturbingly, wealth creation can create a trigger of “wanting more” as the market keeps rising. This neurological effect is scientifically similar to the rush a drug addict gets from cocaine.
First, a feeling of safety forms. Then “wanting more” builds on the back end of that complacency, normally coinciding with the time when the market is most susceptible. This is happening now with a historic level of bullishness per reports in January. (1 source: Barron's Jan 2020)
Reactions over the last 14 months somewhat prove this. In late 2018, a few clients contacted us with worry when the market plummeted 9% in December of 2018. Yet not a single client initiated a conversation about greatly reducing risk during 2019 while markets started increasing substantially. However, over the past few weeks a few calls trickled in about purchasing stocks once clients noticed very large gains last year.
Chasing returns is not prudent. This is a time when having a sound investment philosophy is important, along with balanced emotional reaction to your financial well-being.
What Happened in 2019?
What a difference a year makes. The January 2019 newsletter touched on a potential upward bounce in the market if the Fed reversed course after hinting at tightening in late 2018. They didn't just reverse course. They pulled a U-turn in 2019, lowering rates three times, and the market skyrocketed. This is the key factor in propping up this market. Low rates support high stock prices by making future earnings worth more. It’s that simple.
This trend could continue, although likely shorter-term. It is a valuable lesson that timing the market is a fool’s errand. But we are in the 8th or 9th inning of this economic game. Alarmingly, both GDP and company earnings were essentially flat in 2019. Yet the market was up ~30%. This tells us there was no real economic productivity, just a surge in asset prices because the Fed is simply cooperating... yet again. Long term, this seems counterproductive and just isn’t healthy.
Market Statistics - 2019 (2-Source: Morningstar Jan 2020)
- Overall US Stock Market +31%
- Global Stocks excluding US +22%
- Apple and Microsoft and tech stocks accounted for much of the S&P 500 return.
Interest Rates and Debt
- The national debt has increased 2X in ten years (in dollars and as a % of GDP).
- State and municipal debt is even more alarming.
- State Pensions are severely underfunded with only 2 states fully-funded.
- Corporate Debt has outpaced GDP for years.
- Interest rates remain suppressed. (4 Source: FPA Mutual Funds Jan 2020)
- The above conditions were created in an expanding economy which is completely counter-intuitive.
Debt, interest rates and tax reform are the true creator of stock appreciation.
2020 and beyond— Tempering Expectations
There isn’t much reward without taking an above average amount of risk today with most risk assets inflated. From 2000-2002, as the tech bubble was un-sizzling, there were sectors like healthcare, basic materials, small caps and preferred stocks that were attractively under-priced. That kind of opportunity is much, much slimmer today, especially after this recent surge (Source – First Eagle Jan 2020).
Second, while some believe that interest rates will remain low, it is not an impossible scenario for U.S. bond yields to spike if rising debt levels continue. The crystal ball is foggy at best, and I still am still yet to bump into Dorothy. However, existing rates coupled with rising fiscal debt and deficits, make long term U.S. treasuries and bonds potentially less of a safe haven than in the past.
Lastly, the Fed does not have the ammo to continue to cut rates at their disposal with rates close to zero. Politicians and policymakers alike are misusing the last crisis as justification to further manipulate the system during this economic expansion. The Federal Reserve’s role is to monitor and maintain the health of the economy. Continuing to give the market a quick dose of “medicine” isn’t healthy.
“Decreasing rates are not a sign of economic health, but rather a sign of future economic weakness. Recessions cannot be prevented, only delayed, or postponed”
-Howard Marks
Conclusion
The stock market will face the music at some point, regardless of the number of tweets and rate cuts. If there is bright light currently, it is the health of the U.S banking system. Global banks paint a much more negative outlook over the next few years.
We will NOT just ride this wave. Our fund partners are prudently re-positioning, and planting new seeds. As is the case First Eagle, the focus is on preservation of capital. Healthy growth is a byproduct of a carefully constructed landscape. Becoming too overgrown will also end up choking itself, sometimes quickly. In the mean-time, it also masks those darn snakes that you are sure recognize in hindsight, but not until after they shock the system.
Simply put, while we are thrilled that portfolios are up double digits this past year, please continue to stay grounded about the potential of future returns and the true health of this economy.
Staub Financial - 5280 Dixie Highway - Waterford, MI 48329 - (248) 666-1844
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
