The first six months of 2019 have been a good year. I mean the stock market gains for the first six months of 2019 would be above average performance for any 12 month period. The S&P 500 is up over 17% year-to-date with the first three months being up about 13% and the second three months adding an additional 4%. International investors as measured by the Europe, Asia, Far East (EAFE) index were up almost 2.5% in the second quarter and up over 11% in the first half of 2019.
The bond market continues its long stretch of low yields. The 10 year US Treasury Bond currently yields around 2% annually. If you had left half your money in the treasury bonds and half in the S&P 500 Index, your total return for 2019 would be almost 10%. Again, not a bad annual return jammed into the first six months of the year.
Where do we go from here? The US is growing at a “healthy tortoise pace”. We are still growing at about a 2% rate which is less than half the growth rate of historic expansions. This month, the economic expansion officially became the longest expansion on record.
Green = Contractions Brown = Expansions
So, do we celebrate by becoming more aggressive and increasing our stock exposure or do we choose a bunker mentality, sell everything and hold only cash? I would suggest neither.
I’ll admit that we are in the late stages of this expansion. We are in the late innings of a 9-inning baseball game. But we could have extra innings this time. If you don’t like baseball analogies, I’ll give you a theater analogy. Most plays have two acts. But we may be watching a play with a possible third act. (A quick shout-out to my cousin who helped me with the theater analogy!)
The truth is that economic expansions don’t die of old age. They are typically assassinated by the Federal Reserve by raising interest rates to cool down an overheating economy. But I don’t see many signs of overheating in our economy. Home building is slower and really hasn’t recovered since the great recession that started in 2008. We also have record student loan debt slowing the housing recovery. Car purchasing has been stable. Business investment as a percentage of Gross Domestic Product (GDP) is average.
One area that could cause worry is unemployment. Normally, to have unemployment this low would cause inflation as employers need to pay higher wages to keep and attract good employees. Currently, our full employment economy isn’t causing wages to rise…yet. We are still currently at a time where everyone can get a job, but no one can get a raise.
Slow, steady growth and low inflation is an environment where the Federal Reserve will be very reluctant to raise interest rates. Don’t get me wrong, the next recession is inevitable. So, where do I see the risks on the horizon?
Let’s talk tariffs. Tariffs reduce trade which hurts everyone, but the pain is not felt equally. A reduction in trade hurts businesses and countries that export goods to other countries. The US exports 8% of our GDP. By contrast, Mexico exports 37% of their GDP. Tariffs would hurt the Mexican economy more than 4 times as much as the US economy. Other examples: China and the Eurozone exports 20% of their GDP respectively.
Higher corporate debt is another risk. Increased borrowing by corporations shouldn’t cause a recession but companies with large amounts of debt will be hurt in the next recession.
I need to look further out on the horizon for my next risk which is our budget deficit. The difference between what the US government brings in versus how much it spends annually is now more than $900 billion. This is unprecedented for a non-wartime economy. No one in Washington seems to care: not the democrats nor the republicans. Maybe Senator Rand Paul cares but no one listens to him anyway. Countries and people can live beyond their means for a while but not forever. If we consume more than we produce today, sometime in the future we must produce more than we consume. This is not a great future to leave for our children.
Of course, there are other potential threats including Mideast tensions that could escalate into a war, a hard-landing Brexit, as well as other numerous potential risks.
So, my recommendation is to stay diversified with a proper asset allocation. If you’re not in one of our model portfolios, you should call us. Our investment philosophy at New England Capital is goals-based and long-term focused. We rebalance our models which can enhance performance and keep our portfolio risks aligned with your tolerance and your goals. We make adjustments to our models as market conditions and manager changes occur.
Staying calm with a long-term focus can prevent being whipsawed when the market overreacts to every bit of news or tweet from our 24/7 news cycle. The ugly 4th quarter of 2018 will continue to fade in our memories. As a matter of fact, the only investors that will remember how poorly the stock market performed at the end of 2018 are the ones who panicked and sold their investments and didn’t experience the positive performance in
2019.PLEASE SEE IMPORTANT DISCLOSURE INFORMATIONat www.newenglandcapital.com/disclosure