To My Clients, Friends, & Observers
Leading economic indicators through March declined for three months in a row to 25, the lowest level since June 2009, according to the American Institute for Economic Research. (50 is neutral.) In April leading indicators rebounded to 38 but remained below neutral. Coincident and Lagging indicators remained at 83 and 67 respectively. The strength and durability of the economic expansion is questionable. While the trend is down, it may be reversing and the pace of decline has been mild, suggesting a slowdown rather than a recession. The government shutdown in December and January significantly disrupted economic activity and timely reporting of data from the Commerce Department as well.
More importantly for investors, corporate earnings and revenue growth continue, albeit at a slower pace, growing 3% to 5% for the year. First quarter earnings are exceeding forecasts. The bull market is in its 10th year, having technically avoided a bear market last fall when the S&P 500 dropped 19 ½%. (A 20% drop would define a bear.) How long this will last I do not know but I see no compelling danger signals as there were in 1999 or 2007.
Interest rates are still historically low and the Federal Reserve has stopped hiking for the foreseeable future. The ten year US Treasury yields 2.4%. The S&P 500 is priced at 21.8 times its trailing 12-months earnings. That translates to an earnings yield of 4.6%. The equity risk premium is well above its historical average. There are $3 trillion sitting in money market funds, looking to be invested. The returns from the market are more attractive than cash or bonds.
The U.S. has the lowest unemployment rate in 50 years. Real incomes are increasing. So is the savings rate. The consensus for GDP in 2019 remains 2.9% to 3% as it was in 2018. A look at the Baltic Dry Index suggests that global economic activity is actually improving. Inflation remains benign. A market top does not look like this. An S&P 500 at 3200 by year-end seems realistic assuming status-quo.
The biggest threat to growth would be an all-out, protracted trade war. A fair, enforceable agreement between the U.S. and China would be so beneficial for all parties that one almost has to assume such an outcome.
Investing in securities is risky
It bears repeating. It is always timely to consider your risks. Nothing is guaranteed.
Consider carefully if you could withstand a portfolio decline of 55%. That was the top to bottom of the market from October 2007 to March 2009. Consider carefully how much of a decline you could stomach and for how long. While we can’t control the market, we can mitigate its effects on our personal finances. We use Sharpe’s beta formula in an Excel spreadsheet to illustrate systematic risk exposure to market assets.
Dennis M. O’Connor