3rd Quarter 2019 Commentary

The year so far – from Jan. 1 to the end of the third quarter of 2019 – has basically been a continuation of the average markets for the last decade. Emerging Markets are up almost 5%; Developed Markets outside the US are up about 11% and the US market is up about 18%. None of these returns have come in a straight line, volatility has been alive and well in 2019. We should all expect volatility to continue.

Gross domestic product (GDP), which is the most accepted measure of current economic growth, is still hovering around the 2% area. The first quarter’s GDP was 3.1% and the second quarter was 2.1%. Expectations for the third quarter are just under 2%. The Atlanta Federal Reserve Bank’s GDPNow forecast is suggesting 1.8%.

The jump to 3% and the subsequent slowdown (read: return to 2%) was baked into the numbers when the tax cuts were passed. Given productivity growth (1.2%) and employment growth (.8%), our long-run GDP target is pretty much capped at 2%. Big fiscal or monetary stimulus can push us higher for a short time; busting bubbles or trade wars can pull us lower for a short time… but there is a gravitational pull back to 2% unless and until there are changes in either productivity or employment growth.

Media made a big deal out of the yield curve this quarter because, historically, inverted yield curves have presaged recession. The yield curve inversion occurred in late August when the 2-year Treasury was priced to pay more interest than the 10-year Treasury. But… while I am loath to say that “this time is different…” This time IS, in fact, different. The changes to the monetary policy arsenal coming out of the 2008-2009 Great Recession create an environment where yield curve inversion can’t possibly mean the same thing it did before.

Before 2008, the FED would raise or lower interest rates in order to control the money supply that would in turn speed up or slow down the economy. The 2008 introduction of QE (quantitative easing), increased the monetary base by over $3 Trillion less than half of which became additional currency in circulation. The difference between the two became “excess reserves” that banks held at the FED. In order to incentivize the maintenance of excess reserves, the FED started paying banks IOER (interest on excess reserves).

Excess reserves and IOER are an entirely new tool the FED uses to ‘manage’ the economy and they have changed the entire nature of the relationship between the yield curve and the money supply.

Throughout the quarter, especially since the yield curve inverted, there has been constant reference to the “R” word – Recession. Recession talk has taken up residence in the media echo chamber. However, even as it has softened a little bit (as expected coming off the tax-cut sugar high) the data are still mixed and leaning positive. It looks a lot more like a simple slowdown than it does a stall or a decline.

Here are two important positive things that no one is talking about. If – by the way – you’ve heard about these, I would love to know where.

First, the S&P 500 at 3000 stands 4.3 times its panic 2009 low (that’s 430% higher). And… while the equity market return has been wonderful, we have also seen a resurgence in dividend increases. So much so that the expected dividend on the S&P 500 in 2019 ($57-$59) is a tad higher than the earnings were in 2009 ($56.86). Over 10 years the dividend has more than doubled (From $22 to almost $57). If you were retired on your dividend income alone, then your income increases have far exceeded the required increases of inflation. If you are not retired, then your dividend reinvesting has been equally positive for your future retirement.

Second, unemployment is sitting at 3.5%. This means that 96.5% of people who want to be working are working. The last time it was this low was 1969 – 50 years ago. And, there are more job openings listed than there are people to hire. And, perhaps long overdue, wage growth has been above 3% since mid-2018 and is sitting at 3.5% as of the last reading. These are very positive numbers… but the real story is behind these numbers.

These wage increases are not evenly distributed among the “production and non-supervisory” workers. The majority of those wage increases are going to the lowest-wage workers. In spite of the ongoing trade issues effecting export heavy industries, the lowest-wage workers are seeing wage increases of nearly 5% on average due to a combination of a very tight labor market and policy (higher minimum wages). Medium-wage workers are seeing their wages increase right at 3% and high-wage workers are seeing wage increases between 2.5% & 3%.

And… there are risks. Against the backdrop of an incredibly strong US consumer sector, businesses are nervous. The uncertainty from trade policy and the hard line on legal immigration has businesses sitting on their hands. The weakest item in the economic outlook continues to be business investment. We have seen similar dips in this area in both 2015 and 2016 (neither of which led us into recession). Right now, it is a thing to watch… not a thing to cause worry.

Finally, a comment on congressional legislative action. The bipartisan SECURE Act passed in The House of Representatives with only 3 “nay” votes. The bill may never reach the floor in the Senate, but it could be passed by attaching it to other legislation. There are 2 big changes in the SECURE Act that will affect most of you:

  1. The minimum age for required minimum distributions (RMDs) from IRAs would be moved to 72 from 70 ½.
  2. The “stretch” IRA would go away as a planning tool and heirs would have to fully distribute inherited IRAs within 5 years.

As always, most of the issues I have discussed might have an effect on the short-term gyrations of the market and your investments, but almost none of them will have long-term consequences. The more you can be patient and stay disciplined… the better off you will be. If you have questions, please let us know.