Investment markets can be confusing. To try to cut through the chatter and investment slang, we present this monthly view to you. We want to give you a 50,000-foot view of market conditions updated as our view evolves.
Currently, our Investment Climate Indicator remains at Stormy. Stormy means that bear market rules apply, and we believe could be a period of wealth destruction.
Sure, I know. It's April showers that bring May's flowers. But after a dive in May and a sharp upswing in June, please excuse me for using this headline now. Speaking of headlines, here are a few I have read recently: Stock Market at New Highs, Best June Since 1955, Best First Half in 22 Years. Those are nice to grab the reader's attention, but they don't really tell you the context. For instance, the best periods for stocks (statistically speaking) tend to come on the heels of some of the worst.
And while this is not the gyration level of 2008/2009, or 2002/2003, or even 1987, it is a microcosm. So, here is a chance to reset your perspective, and look forward.
When we look back just a bit further, we recall that the fourth quarter of 2018 was historic, too. That is, it was historically bad. And when you combine those last three months of 2018 with the first 6 months of 2019, you get a 9-month return of 2.3%.
That is not awful, but it certainly does not rationalize the continued feeling of excitement that comes out at times like it did in June. There is still a buy-the-dips mentality on Wall Street, and until that habit ends, the reckoning of 10 years of reckless spending and risk-taking by all phases of the economy will continue to stay in the dugout and off the field.
Ironically, U.S. bonds (represented by the Barclays Aggregate Bond Index) have outperformed stocks by a wide margin over that time, up over 7%. But that is a short-term gain, but long-term mirage, as I will explain. The "Eye of the Hurricane" scenario I have discussed here all year is still intact. June just shifted the winds in a direction that allows the sun to stay out a bit longer.
For retirees, aggressive capital preservation is still the name of the game. That means your investment choices must consider how to identify above-normal loss potential in your portfolio, not only where you can make money. That is a necessity at this late stage of the market cycle.
June was a great month for the stock market. The S&P 500 Index rose 5.1%, and finished the first half of 2019 with a whopping advance of over 18%. However, let's not read too much into that. For instance, the June gain, nice as it was, is not even the highest gain in a month this year. More importantly, anything can happen in a month in the stock market.
The bond market continues to be weird. However, as opposed to the past few months, there is some clearer rationale for the gyrations in U.S. Treasury rates. Concern about rising rates has shifted to an urgent need (by market participants) for a cut in rates... or, truth be told, for a series of rate cuts. This tells me two things: the market feels strongly that the Fed holds the cards in the game of extending the long economic cycle. And, those same investors are ignorant to history.
Related news: Federal Reserve Chairman Jerome Powell told Congress Wednesday, July 10 that the U.S. economy looks "solid" but that he sees risks from an apparent slowdown in the global economy and an inflation rate that has stayed stubbornly below the central bank's 2% target.
After all, when the Fed shifts from raising the rate they control (which is the shortest-term overnight borrowing rate) to decreasing it, that typically means the economy is about to enter recession. Furthermore, those rate cuts tend to help the markets for just a little while, if at all. So, as they say, be careful what you wish for.
2019 looks great so far, until you remember what it followed:
Key Market Stress Points
- Fed rate decisions: The market is convinced that July starts a rate-cut cycle. See above, and also remember that when the market is disappointed, it tends to throw a fit.
- Geopolitical: U.S.-China trade talks continue to drag on. Markets will only be patient for so long. Meanwhile there are many international hot spots, right now, any of which could shock investors. At times like this, it doesn't help that the U.S. Congress is a place where compromise goes to die.
- Valuation: Stocks are still historically overvalued, with the Shiller CAPE version of the price-earnings ratio near its 1929 level.
- Index mania: Assets continue to pile into S&P 500 Index Funds. This group-think will likely contribute to creating the next bear market panic.
- Credit: Massive growth in consumer credit is unsustainable. This decade, it's student loans, car loans and more. It is not just about mortgages and credit cards.
- Bond market risks: Approximately 50% of bonds in investment grade bond funds are rated BBB, the lowest of the four possible rating categories. This is like when too many people try to jam onto the subway car.
- Sentiment: IPO-fever has intensified, as it did in the dot-com era. Media coverage of the stock market is dominated by companies that don't make a profit.
It has been about 20 years since I have seen what I see now: a stock market cycle in its very late stages, but with the possibility of one more big run-up. In fact, I suspect that a big move in either direction (up or down) as 2019 continues is more likely than the recent churn we have seen. That is one of many possible scenarios from here. We all want to grab all the upside that we can. But the risk of major loss is the primary factor many of us must consider in our approach. So, what's the action plan?
My portfolios shifted their risk level a bit higher during June. However, we are at a stage of the market cycle where any risk-management move must include a determination of what your next steps will be. That is, every move today (whether to add or reduce risk in exchange for more or less potential return) should be part of a multi-move sequence. The next moves will be based on how the reward-risk tradeoff changes next.
It is an ongoing plot in an uncertain story. So, just as my portfolios sit at a risk levels that I would consider to be middle of the road, a continued melt-up or a meltdown are both possible from here. That means that two sets of next moves are lined up, ready to go as the next chapter unfolds. This is all part of what I call aggressive capital preservation.
I am neither bull nor a bear. I am a realist and a devout risk-manager. Be careful, understand what you own, and respect the laws of gravity.
Strong returns over all periods shown. This has also led to a yield-starved market, shown by the 2.37% average yield of the Sungarden ETF 100.
Small caps of all types continue to lag larger stocks. In an S&P 500-obsessed world, this is one of the fallouts. That is, any stock not among the very largest in the U.S. market is at a disadvantage, as so much money is trying to track the S&P 500.
Materials led the way in June. That sector was down over 8% in May. Energy stocks are still the laggard the past 3 years.
Gold stocks were the industry flavor of the month, rising 25%. This brings their 3-year return back up to nearly flat. Mortgage REITs now yield 9% as a group. Nice yield, but it also speaks to a precarious situation for the debt markets.
In a generally strong month for stocks, the Internet sector was a laggard.
In a market hunting for yield, there are several ways to get it here. However, as has been the case for about 3 years, higher-yield stocks are underperforming the S&P 500.
Marijuana stocks took a hit. The hype of early 2019 has faded for now.
Despite all of the concerns about Europe, stocks there had a great first half of 2019, up nearly 18%.
Treasuries of all maturities added to their 2019 gains in June. However, check out those 3-year returns. Bonds are in a bear market, and a temporary "flight to safety" amid rate-cut talk does not change that.
Nice months for convertibles and high-yield bonds do not change the outlook: When investors finally start to get concerned about the debt pileup, these areas are as vulnerable as the stock market.
Natural Gas has had quite a spill. But in June, it was not at the expense of higher oil prices. Gold surged and is threatening a long-term breakout after an unremarkable few years.
Source for all ETF data: Ycharts.com.
About the author: Rob Isbitts is an investment strategist and portfolio manager for high net worth families with over 30 years of industry experience. Over the past three decades, he has managed daily liquid portfolios through diverse market conditions. A thought leader and founder of a boutique investment advisory firm in South Florida focusing on breaking investment myths and bringing common sense analysis to his audience, he has authored two books: "Wall Street's Bull and How to Bear It" (2006) and "The Flexible Investing Playbook" (2010), plus over 300 articles on investing. Connect with him on LinkedIn and follow him on Twitter @robisbitts. Rob's website is Sungardeninvestment.com.