I update each Saturday with my view of the stock market for the next few weeks. The monthly “Long Term” update will be on a Wednesday soon after the 15th of each month, and this supports investors who want to buy and hold, but want to sell to avoid the bulk of a crash, and buy back in for most of the next bull market. You can always scroll down a few weeks and find the latest “Long Term” update.
If you lose your bookmark to the blog, google “Rich Investing” and it should show up on the first page or so. The more often you google it and hit the link, the higher it will show in your results.
New-home sales ran at a seasonally adjusted annual rate of 553,000 in September, the Commerce Department said Wednesday, swooning to the lowest since December 2016. September’s selling pace of 553,000 was 5.5% lower than in August, and 13.2% lower than a year ago while the median price dropped 3.5% to $320K. Initial jobless claims rose by 5,000 to 215,000 in the week that ended Oct. 20, still near a 50 year low (initial jobless claims is a “trailing indicator”, the economy goes bad, then employers lay off workers). Durable goods orders increased 0.8% in September, the third gain in the last four months, but excluding defense spending they fell .6%. Gross domestic product (GDP) decelerated a bit to a 3.5% annual pace in the third quarter, a drop from last quarter’s 4.2%, but still the fastest six month gain in 4 years. Below the headline number, there is a slowdown in business investment. Businesses hate uncertainty such as the trade war with China, and in the face of uncertainty they stop committing capital to new projects until the situation stabilizes. The final reading of the University of Michigan’s consumer-sentiment index in October was 98.6, marginally below September’s level of 100.1.
Things look generally good, but housing is a definite concern. One might think that the slight uptick in mortgage rates to 5% on a 30 year fixed is not too bad, we have seen rates that high before (my second house in 1978 the mortgage was 8.25%, but a nice 2400 sq. foot new house only cost $75K). But due to housing inflation greatly exceeding the general inflation rate, we have not seen these higher rates when the median selling price is $320K. Housing is a huge important sector of the economy and when it slows, it backs up into the rest of the economy.
With the drop in the stock market, the trade war with China, the Fed raising interest rates, a slowdown in housing and the slight drop in consumer sentiment, the headwinds are building for the economy.
Let’s take a look over at Europe as Mario Draghi just gave an update on economic activity on Thurday.
“Oct. 25, 2018 – Rising interest rates. Brexit. Trade tensions. The danger that Italian banks could become victims of their government’s war of words with the European Commission.
All these risks have helped roil stock markets in recent days, Mario Draghi, the president of the European Central Bank, acknowledged on Thursday.
But none of those hazards were enough to budge Mr. Draghi or the bank’s Governing Council from their conviction that the eurozone economy is fundamentally solid.
That message — that the eurozone economy is growing less briskly, but is not on the verge of recession — was perhaps the main point of Mr. Draghi’s news conference in Frankfurt after a meeting of the bank’s Governing Council.
The council left its benchmark interest rate unchanged at zero and made no changes to its timetable for slowly withdrawing economic stimulus.”
That generally sounds good. BUT….
Growth is slowing in Europe, do not miss that message, and they are still on schedule to end their QE bond buying program by December. That will suck up private capital and reduce liquidity to buy the bonds that the ECB formerly bought.
Growth is slowing in Europe, growth is slowing in China. Growth slowed in the US from 4.2% GDP in Q2 to 3.5% in Q3. The US has launched a trade skirmish with Europe and a trade war with China. Guess what, that is not good for business, and what is not good for business is not good for the stock market.
The real debate for the US economy is what will be the long term impact of the Trump tax cut? The republicans tell us that growth will be accelerated from 2% to 3% on a long term basis and that change will allow us to grow out of the awful $800 billion budget deficit that CBO projects will be $900 billion for 2019 and $1 trillion in 2020. Many economists argue that the CBO is right, that the tax cuts will produce a temporary “sugar high” in the economy where corporations and individuals see a difference in their cash balance and spend some of that, boosting the economy. But after that initial surge in spending, it will become life as normal and no longer boost economic activity higher than the level initially reached, so after a year, no higher growth. From corporations, most of the money is going to buying back their own stock, which they do to cover up the looting of the companies through stock dilution by top management in their excessive stock option programs (issuing new shares that primarily go to top management). We won’t know the answer to that question for two more years, we’ll just have to watch the GDP numbers.
The week just ended was rough, down 3.6% on the S&P. Clearly there is a correction going on, or did a bear market just start? We don’t know right now but this late in the expansion it is prudent to ask that question and be prepared to deal with it if that is what is going on.
A bear market starts when the last stock market cycle high is hit, not necessarily when the recession starts (when GDP goes negative for 2 consecutive quarters is the standard definition of a recession). Leading up to the financial crisis, the market peaked in Dec. 2007, but the recession did not start until the spring of 2008, since Q1 of 2008 had positive GDP. The stock market is a forecasting mechanism, looking ahead about six months usually. The pros have access to tons of data and they watch for small changes in key indicators that they believe forecast what is to come, but is not yet apparent to those that just watch the larger “headline” numbers.
Technically, the market is in a precarious position. The market is down 9% from its recent high, and closed the week near its closing low for the week. We have not found stability. Relative strength (the RSI index at the top of the chart) is at 30 which is oversold. In a bull market buying in at oversold areas usually turns out well, see the occurrences this year in Feb. and March. The question is, are we still in a bull market? No new base has formed and with the concerns discussed in the previous section (Geo Political), it is too early to make a bet on a turnaround in the market. Momentum measured by MACD at the bottom of the chart is very negative and there is no bottoming in sight. Price action is very negative, having violated support at 2700 at the early July low. The next support is back at the early April low of 2580, another 80 S&P points down, roughly another 3%. I don’t know if we’ll go down and test it, and if we do, whether that support will hold. We’ve broken down on every other traditional support level, the 50 day moving average, the 200 day moving average (a very important one), and the bottom of two uptrend channels. It is an ugly picture right now and there is no motivation to invest right now.
I sold out of the market midweek according to the observation I made last week. I took a hit like everyone else who is in the market. I hate to sell in a correction panic, but this late in the expansion and with the headwinds we’ve discussed on rising interest rates, trade wars, housing weakness, the irresponsible expansion of the US budget deficit, slowing growth in Europe and China, the risk of a recession in 2019 or 2020 comes into possibility. Will it happen, I certainly don’t know.
I bought a 1 year brokered CD at Fidelity at 2.7% interest with some funds (it pays monthly). The money market is paying 1.7%, so that gets me a 1% premium. The Fed has said it will raise rates in Dec. and 3 times next year, so this CD will outperform the MM all year, and it’s fully FDIC insured. If a recession hits, I only want to be in top quality bonds, Treasuries or FDIC insured CD’s. Rates are finally getting to the point that they provide an alternative to stocks. It’s not a great alternative, but its light years ahead of 0% we got in the MM the last 5 years.
FDIC insurance is up to $250,000 per bank on brokered CD’s, so if you invest more than that, use multiple banks. At your local bank, FDIC insurance can be higher than $250K if you properly register the holders of the CD, so one held in joint names such as “John and Sally Smith” is eligible for $500,000 insurance. One “badged” as “John and Sally Smith, pay on death to Rover Smith” is eligible for more.
From the FDIC website, and talk to your local bank:
Q: Can I have more than $250,000 of deposit insurance coverage at one FDIC-insured bank?
A: Yes. The FDIC insures deposits according to the ownership category in which the funds are insured and how the accounts are titled. The standard deposit insurance coverage limit is $250,000 per depositor, per FDIC-insured bank, per ownership category. Deposits held in different ownership categories are separately insured, up to at least $250,000, even if held at the same bank. For example, a revocable trust account (including living trusts and informal revocable trusts commonly referred to as payable on death (POD) accounts) with one owner naming three unique beneficiaries can be insured up to $750,000.
I saw a speaker on CNBC talking about stock market returns and he pointed out that the average annual return on stocks since 2000 has been 3.5% a year, but with a lot of volatility. It makes that 2.7% safe return look not so bad. We all need to reconsider how much we should have in fixed income now that the return is somewhat reasonable. I do not like bond funds in a rising rate environment. I prefer an individual bond or CD, relatively short term where I pick the maturing date. I will allow the Fed to make its projected rate hikes, then reinvest at the higher rate later. By the way, there is no guarantee that the Fed will raise 4 times in the next 15 months because if weakness persists the Fed would probably stop the hikes.
Regarding the CNBC speakers comment about the low return in the stock market from 2000 to today, it could be said that he cherry picked the start to be the top of the “dot com” bubble, a period of the highest stock market overvaluation in history. Of course the average annual return off an all-time high valuation will be low, especially if you throw in a “financial crisis” in 2008. If he picked 1990 as the start date, the average annual return would be much higher. This is a true comment. It is also true that for many people, they were fully invested in 2000, they were told to “buy and hold for the long term”, and they did in fact experience the 3.5% average annual return since 2000.
The question I have raised before is: Can the govt. respond to the financial crisis of 2008 by carrying the economy by issuing debt through bonds from the Treasury bought by the govt. at the Fed, to the tune of $10 trillion (4 trillion at the Fed plus 6 trillion to the rest of the world), and have no major negative repercussions? The short answer is nobody knows because we’ve never done it before. My gut tells me that there will be a long term negative repercussion we will have to deal with, and that is why I’m cautious late in the current expansion. I don’t know what will happen in the next recession, but we may have fired all our heavy artillery at the last “great recession”.
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You can use the hyperlink below the chart of the S&P that will open a larger picture of the chart in a separate window. The reader who suggested this wants to look at the chart side-by-side with the blog text so he can look at the chart while reading the text. To do this in Firefox you can open a “private window” from the browser menu and have two instances of Firefox up, then size each window to about half of your monitor size. If you bookmark the link you can look at it each day of the week to see how the market is progressing to certain milestones.
Rich Comeau, Rich Investing