Lions and Tigers and Bears, Oh My
By Todd Gray, Portfolio Manager
“Toto, I’ve a feeling we’re not in Kansas anymore.” ~ Dorothy in The Wizard of Oz
Departing from our normal approach of addressing one particular investment theme in each newsletter, I instead would like to briefly address several issues which have dominated the financial news of late and have caused investors to have their own “Oh My” moment, like Dorothy and her companions on the yellow brick road.
Paying no interest on a mortgage? Paying interest to own a bond as opposed to receiving it?
We are certainly not in Kansas, Toto! We are in Denmark, where Jyske Bank recently offered a 10-year fixed-rate mortgage at negative 0.5% and Finland-based Nordea Bank announced that it will offer a 20-year fixed-rate mortgage inDenmark that charges no interest. There are currently more than $16 trillion in negative-yielding sovereign debt instruments around the world, as central banks try to ease monetary conditions to sustain the global economy. The 10-year sovereign bonds in Belgium, Germany, France and Japan, among others, are trading with a negative interest rate. Suddenly, the current 1.5% yieldon the 10-year U.S.
Treasury doesn’t look so bad! Could negative yields happen here in the U.S.? The question investors may eventually have to ask themselves is how much would they be willing to pay (pay, not receive) for the safety of investing in a non-risk investment such as a Certificate of Deposit or a Treasury Bond? From an investor standpoint this type of interest rate environment is a big positivefor risk assets, especially stocks.
I have heard the term “yield curve inversion” more in the past two months than I have in my thirty-two years in the investment business. What is an “inverted yield curve”? It is when the yield on long-term bonds falls below that of short-term bonds. Whatdoes this mean to you as an investor? The yield curve has inverted before each of the last six recessions. In and of itself, inversion does not cause a recession, but can help to diagnose one. The problem from the viewpoint of an investor, is that inversion does not pinpoint exact timing of recessions or how fast economic conditions will decline. It also has not been a timely signal of when investors should reduce portfolio risk as the stock market can continue to perform quite well after a yield-curve inversion occurs. The most accurate and timely indicator of a recession has been when the ten-year U.S. Treasury bond yield has fallen 25 basis points (¼ of 1%) or more below the yield of the two-year Treasury, or when an inversion has lasted for at least four consecutive weeks.
The question I am most often asked these days is are we going to have a recession? The answer is unequivocally yes!
A surprisingly straightforward answer coming from someone in the investment business! The catch is that I don’t know when it will occur or how long it might last and neither does anyone else. In a recent survey of economists, 40% believe the United States will fall into a recession before the end of next year, while 60% believe it will occur in 2021 or later. What is a recession? It is generally defined as two consecutive quarters of negative economic growth. Are recessions a rare occurrence? No. Since 1950 there have been ten recessions. Does the stock market always decline during a recession? The answer is no, as the S&P 500 Index has had positive returns during five of the ten recessions since 1950. The returns for these periods of recession have ranged from being up 16% to down 37%.
The implementation of tariffs on certain types of goods imported from China (and in China on U.S. goods) has dominated thefinancial news and has had an impact on the stock market. How do tariffs impact consumers and investors? In simplest terms,a tariff is a tax. It is important to recognize that the tariffs owed on imports are paid by the importer, not by the foreign country,in this case China. Thus, tariffs increase the cost of the goods paid by the importer. Businesses importing goods must either eat the additional costs, thereby reducing their profits, or pass part, or all, of the tariff on to their customers. Thus, as a consumer youare impacted by having to pay higher prices and as investor you are potentially impacted by owning companies facing declining profits resulting from either not being able to pass along all the additional cost of the tariff, or from declining sales growth as customers reduce their purchases due to higher prices. If the current tariff war with China were to accelerate or expand from here, then that would certainly be a drag on corporate profits, economic growth and stock returns. However, if China and the U.S. were to come to a trade agreement then this would likely be a great boost to the stock market.
A couple random facts to ponder: A 65-year-old currently spending $100,000 per year for living expenses today will need $128,008 per year by age 75 and $163,862 at age 85 to pay those same expenses, based on an inflation rate of 2.5% per year.Therefore, we strongly encourage clients of all ages to maintain some degree of exposure to stocks throughout their lives to maintain buying power.
Speaking of stocks, you have often heard us say that we are “long-term” investors. This is not just some old, overusedphrase to us but a belief that is derived from a study of the history of stock market returns that have shown a significant portion of stock market returns has been generated in a small number of trading days. The total “cumulative” return of theS&P 500 Index for the ten-year period from 2009 through 2018 was 243%. The 25 best trading days during this time period (out of 2,520 trading days) produced a gain of 162.9%, or 67%, of the total return for this ten-year period.
The yellow brick road of investing does not always travel in a straight line and from time-to-time investors may experiencesudden unseen dips in the road. However, by keeping events in the economy and the markets in proper perspective, we can avoid taking financial actions resulting from the cries of “Lions and Tigers and Bears, Oh My” by the financial news media thatcould have harmful long-term consequences for you.