- Stocks have reclaimed most of the losses of the 4th Quarter of 2018 with all asset classes participating in the march up as deteriorating global economic conditions seem to have stabilized.
- The disparity between interest rates available for cash saving options are broad and represent a great planning opportunity at this time.
- Global economic conditions may have stabilized, however, economic indicators are still coming in below consensus. This is especially significant in China where debt and housing are major issues.
- The retirement savings gap is the crisis we believe will be a major issue over the next three decades, and one we believe can be addressed with good planning.
The first quarter of 2019 is a complete reversal of what we experienced in the last quarter of 2018. To date this has been a classic V-shaped recovery across all major asset classes with the speed and magnitude of the market fall equally matched by the recovery. Cash, the winner of 2018, is now bringing up the rear, returning .6% while real estate has led the way forward. The evenness of the recovery has been comforting with both international and domestic markets advancing.
The concerns of yesteryear may be hard to remember unless you work for the Federal Government. As a reminder, we were entering what became the longest government shutdown in the history of the U.S. right before the Christmas holiday. In addition, global economic indicators were deteriorating, a situation which has persisted in 2019 but shows signs of stabilizing. For the time being these concerns have been shaken off by the market for reasons which we will do our best to address later in our update.
UPDATE ON BREXIT
Brexit is still a concern; to date there is no resolution and the political landscape seems like it will become more challenging rather than less as the UK, still an EU member, participates in upcoming European Parliamentary elections in late May. If nothing else, the removal of options from the table may be the only positive from how long this has dragged. “The French president’s (Emmanuel Macron) central point during the dinner on April 10 was that the UK would not make up its mind unless it was confronted with a hard deadline.” The longer this takes the more likely it becomes that a second referendum will be presented to voters in the next 5 months or a hard exit from the European Union will take place in October of this year. In either case this will hopefully provide a path forward out of the gridlock in the British parliament of the last 2 years.
WHAT TO DO WITH CASH
As we discussed in our last update, interest rates on available savings options vary by a wide margin depending on the solution used. We are in an environment where the difference between well-planned cash holdings versus simply holding funds in a bank account has significant impact on return and ability to pace inflation. Holding cash can be beneficial for a variety of reasons such as emergencies, large purchases, dollar cost averaging in to the market, float for businesses, etc. Likewise, holding cash can be very bad if you are losing purchasing power due to inflation.
The light gray bar represents traditional savings accounts. The dark gray bar represents the average of money market returns. As you can see from the illustration above the difference between the two cash alternatives is historically minor with the two options generally mirroring each other. However, in the last 2 years the difference between them has jumped. Our experience working with clients has led us to believe that many people are experiencing a scenario even worse than the averages illustrated. Primarily this is occurring because traditional banks, where most cash is held by the typical consumer, still have rates as low as .05%. On $100k in holdings this is the difference between earning $50 versus $2,133 on average.
Our point is this. If you have not looked at what your cash is earning lately, now is the time to do it. With a little bit of planning you can earn enough to pace inflation with your savings as opposed to not keeping pace. An average gap of 1.7% between what your savings is probably earning versus what it should be earning is a big deal.
GLOBAL GROWTH IS DOWN BUT NOT YET OUT
In our last letter we shared an image of the Purchasing Managers Index to illustrate the slowing global economy. To that end we include it again for comparison. In his last remarks to the press, Fed Chair Jerome Powell said the following, “Since last year, however [sic] we have noted some developments at home and around the world that bear close attention…Data arriving since September suggest that growth is slowing somewhat more than expected. Financial conditions tightened considerably over the fourth quarter. While conditions have eased since then, they remain less supportive of growth than during most of 2018.”
As you can see above, in the top row we have global data holding at a reading of 50.6. This is very slow growth, but it is still growth, and is representative of the “easing” mentioned by the Fed Chair. Despite Brexit, the UK looks favorable, although the Euro area is currently retracting with Germany suffering the most. China moved from a slight retraction at the end of 2018 into minor growth. Economic growth is a lot like pizza: even when it is not great, it is still good. There is nothing exciting in the data except to indicate that we do not believe it is necessary to take extraordinary steps to adjust current financial plans.
China has work to do. They are a huge economy with significant financial issues to be worked out. At the top of the list is a debt and housing problem, which, if not handled properly could create the next major housing related financial crisis. Ironically, the most populous nation on earth has the reverse problem of what we have in the United States.
An estimated 65 million housing units are currently empty. Empty! This is in stark contrast to the housing shortage here in the United States. We have an estimated stock of 136.5 million housing units and need to build more. China has half of that inventory sitting unoccupied.
This is a point worth taking a moment to expand on. Someone in China borrowed money to build housing units with the goal of either selling or renting out those dwellings. The original developers need cash flow in one of two ways: rent or asset sale. When this does not happen, construction debt is moving toward default unless something extraordinary happens. Just ask a developer caught in the 2008/09 financial crisis how things turned out if they were unable to rent or sell developed units. This is a terrible scenario for developers and provides some context for Chairman Powell’s comments on China recently. “I would say, tariffs may be a factor in China. I don’t think they’re the main factor. I think the main factors are the delevering campaign that the government undertook a couple of years ago and also just the longer-term slowing to a more sustainable pace of growth that economies find as they mature.”
The delevering he is referring to is the scale back of the debt load incurred to build out infrastructure of which the housing stock is a large component. It is not a stretch to say that if conditions do not continue to improve it may be a Chinese housing crisis which leads the world to its next economic downturn. For the time being that risk appears to have been stayed.
A SPOON FULL OF SUGAR
The Citi Economic Surprise Index is an aggregate measurement by region of various economic indicators. Being above the line is a good surprise and below the line is a bad surprise. Economic indicators such as the PMI data referenced earlier, inventory change, unemployment, and job growth are factored in along with many others. The index is at its lowest point since 2013 representing a high level of bad news which helps explain why stabilization is a positive improvement. The spoon full of sugar to help the medicine go down is that the Federal Reserve is holding rates right now and sees the global outlook as stable and not deteriorating. To be specific, they see the Fed Funds Rate as being neutral – “the rate that tends neither to stimulate nor to restrain the economy.”
Our concern is that if conditions do not continue to improve from today, the last quarter of 2018 may return quickly. Steve Blitz, Chief US Economist at TS Lombard a leading global economic research company, explains it this way: “We are left with an economy that can ill-afford the loss in wealth from a bear market and with market structures unable to handle a massive reversal in the flow of investment monies.” Our belief is that we will continue to see economic improvement through the end of 2019, however, now is a great time to start planning for when we hit the rough patches ahead.,
PLANNING FOR THE FUTURE
Now we will begin to switch gears and move from what has been a subdued conversation to one that we believe is a great opportunity facing those who are actively engaged in planning for their financial future. Our country, and indeed the globe, is facing a crisis. However, it is not the economic cycle we are concerned about. We have the highest faith in the business cycle continuing to move as it always has with hiccups here and there, but otherwise forward advancement creating long term wealth for those who plan appropriately. Our main concern is the retirement gap which is going to increase massively over the next three decades.
As you can see below, the countries with the largest absolute retirement funding gaps are listed in data provided by the World Economic Forum. This funding gap will drag down global growth by shifting investment in infrastructure, production and the like into social safety net programs. These issues are being talked about in big ways right now by the current crop of presidential candidates vying to be the competition to President Trump in 2020.
In the United States funding the retirement gap is done primarily through Social Security and Medicare, in addition to other ancillary programs. These programs, while very useful in creating a baseline standard of living just above poverty, create a lowest common denominator situation. Our preference is to help people plan for something much greater than that. At the qualitative level we do this by suggesting the following:
- Plan for yourself first. This is akin to putting your oxygen on prior to putting it on a child in case of an emergency in an airplane.
- Educate your children. Take an active role in equipping your children and grandchildren in gaining financial literacy.
- Make a budget.
- Take advantage of financial technology. It is now a reality that we can help you get all of your household wealth represented in a central place.
- Save early and often.
Saving early and often is an imperative, meaning it is crucial and should be treated as peremptory. As illustrated in the second individual above it is far easier to save enough when you start earlier rather than later. Compound interest might be the 8th wonder of the world according to Einstein, but if you do not put it to use then it is nothing more than a precept which you never were able to take advantage of.
For clients who are grandparents and parents with older children. If your retirement is in good order now is a great time to start creating a financial legacy for your family. One idea we have is to begin assisting a working child or grandchild with a contribution to a Roth IRA. This gets complicated, but it would be our pleasure to help develop this strategy with you.
THE FUTURE IS BRIGHT
A recently born Exchange Traded Fund, ETF, by the ticker symbol UFO, provides investors with the opportunity to invest directly in space related companies. We bring this to your attention not to suggest investing in the space industry but rather to bring focus on a set of circumstances we find highly encouraging. The world is always moving forward and we can participate in it. As a society we are now attempting something science fiction writers have dreamed about for years, going to Mars and beyond.
Our faith is built on the fact that given time, motivation, and consistency we can all achieve an end which is planned for and should be expected. Life will get in the way and the final product will never be quite what we thought, but it should certainly look close enough to expectations that there is a certainty of outcome. At the end of the day that is what good planning is all about.
We cannot fill China’s empty housing units, or magically transport those dwellings to the areas in the United States where they could be best used. We cannot force other people to save in order to reduce reliance on social programs. But, we can plan well for ourselves, and then engage our children and grandchildren in that planning so that they have a base for themselves. The legacy we build by doing this is one which might actually change the world.
If you are concerned that the projected slowdown may impact your current financial plan please bring this to our attention. We are here to help you make rational, informed and well-reasoned decisions, and we thank you for your continued trust and support. Your input is always welcome, and we ask that you contact us with any questions or concerns.
All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards.
Investing in securities in emerging markets involves special risks due to specific factors such as increased volatility, currency fluctuations and differences in auditing and other financial standards. Securities in emerging markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.
An index is a statistical measure of change in an economy or a securities market. In the case of financial markets, an index is an imaginary portfolio of securities representing a particular market or a portion of it. Each index has its own calculation methodology and is usually expressed in terms of a change from a base value. Thus, the percentage change is more important than the actual numeric value. An investment cannot be made directly into an index.
Investing in fixed income securities involves credit and interest rate risk. When interest rates rise, bond prices generally fall. Investing in commodities may involve greater volatility and is not suitable for all investors. Investing in a non-diversified fund that concentrates holdings into fewer securities or industries involves greater risk than investing in a more diversified fund. The equity securities of small companies may not be traded as often as equity securities of large companies so they may be difficult or impossible to sell. Neither diversification nor asset allocation assure a profit or protect against a loss in declining markets. Past performance is not an indicator of future results.
Securities offered through 1st Global Capital Corp., Member FINRA and SIPC. Steven W. Pollock, Sean P. Storck, Matthew J. Anderson and Nicole Albrecht are Registered Representatives of 1st Global Capital Corp. Investment advisory services, including RBFI portfolios offered through Reason Financial. IMS platform accounts offered through 1st Global Advisors, Inc. Reason Financial. and 1st Global Capital Corp. are unaffiliated entities. Reason Financial is a Registered Investment Adviser. Placing business through 1st Global Insurance Services. Registration does not imply a certain level of skill or training. We currently have individuals licensed to offer securities in the states of Arizona, California, Illinois, Indiana, Kansas, Massachusetts, Michigan, New York, Oregon and Washington. This is not an offer to sell securities in any other state or jurisdiction. CA Department of Insurance License: Steven W. Pollock #OE98073, Sean P. Storck #0F25995, Matthew J. Anderson #0F21959 and Nicole Albrecht #0F99962.
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1 Münchau, Wolfgang. “Realism Is Set to Strike the EU over the Brexit Timescale.” Financial Times, Financial Times, 21 Apr. 2019, www.ft.com/content/f064d5fc-61b8-11e9-b285-3acd5d43599e.
2 Powell, Jerome. “Transcript of Chair Powell’s Press Conference, March 20, 2019.” Www.federalreserve.gov, The Federal Reserve, 20 Mar. 2019, www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf.
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4 Powell, Jerome. “Transcript of Chair Powell’s Press Conference, March 20, 2019.” Www.federalreserve.gov, The Federal Reserve, 20 Mar. 2019, www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf.
5 Goodman, David. “Gloomy News Drags Economic Surprise Index to 2013 Lows.” Bloomberg.com, Bloomberg, 18 Mar. 2019, www.bloomberg.com/news/articles/2019-03-04/gloomy-news-drags-economic-surprise-index-to-2013-low-chart.
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7 Yik, Han. “5 Things You Need to Know about the Global Pension Crisis.” World Economic Forum, 26 May 2017, www.weforum.org/agenda/2017/05/5-things-you-need-to-know-about-the-global-pension-crisis/.
8 Yik, Han. “Millennials (and Gen X) – Here Are the Steps You Should Take to Secure Your Financial Future.” World Economic Forum, 8 June 2018, www.weforum.org/agenda/2018/06/millennials-and-gen-x-here-are-the-steps-you-should-take-to-secure-your-financial-future/.