On this week’s show, Karl discusses the strength of the stock market, despite recent volatility. When the news flow is quiet, stocks have gone up.
Also, there were some dangerous comments made by an ex-Federal Reserve head. These comments was the talk of Wall Street this week.
Growth stocks vs. value stocks. Is there a difference in how investors should research them?
Hey, good morning everybody. Welcome to Creating Richer Lives with Karl Eggerss. Welcome to the podcast. Thanks for joining me. Just a reminder, (210) 526-0057 is our telephone number and our website, creatingricherlives.com. Click on the insights, you can get more information there. The blogs are posted there and the podcasts and so forth. In the next couple of weeks probably you’re going to start seeing all of that information right there on the front page for you and lots of ways to get information from us via email. Or you’re welcome to call us or email, and we will certainly help you out any way we can.
Happy labor day coming up. We have a three-day weekend, and of course the markets are closed Monday. Just a quick housekeeping note, tomorrow morning I will be on CBS, San Antonio doing an interview discussing tariffs, the trade war, and really how it impacts all of us and your portfolio. So make sure you tune into that. It’ll be on at the seven o’clock hour AM, central time. Again, for those of you in the surrounding San Antonio area, it’s on the CBS affiliate.
All right, well let’s jump right in here. Let’s first go through what the major averages did this week because it was a little better than last week. You remember last a week ago, Friday, ended the week, Dow was down well over 600 points. The tariff and trade war was escalated after the bell, Friday, Trump retaliated with more tariffs, and then so we didn’t know coming into this week how the markets would react and we got off to a pretty good start. It was very interesting watching how that all culminated.
But for the week, we did see markets were up about 3%, 2 1/2 to 3% depending on which index you looked at. And it was pretty strong across the board and we had two really good days, Wednesday and Thursday, back to back days where the internals were very strong. And that’s really what we need. Remember we’ve seen some really capitulatory days, a week ago, Friday being one of those where we see everybody just giving up. And then again, as I’ve been saying, we need days followed pretty quickly on those nasty days to get some real intense buying. And we’ve seen that pretty broad based buying. And right now it seems as though the market has an upward bias unless, big caveat, we get negative news, whether it’s the federal reserve or whether it’s President Xi or President Trump or their escalation, or China and the U.S., the markets still do have an upward bias.
So for the week, again, markets were pretty strong across the board. And you’re still seeing, despite the gains in stocks this week, you’re still seeing gains in bonds. I mean, bonds are still having a very, very good year, and most of you would not have guessed that. I’ve talked to many of you over the years that would have said two, three, four years ago, “Eh, don’t really want a lot of bonds because, how much lower can interest rates go?” Well, we’ve seen they can go a lot lower, and we’ll get into that in just a little bit. So bonds have had a very good year. Of course, that kind of reduces your expectations for bonds going forward because of where they have come from.
But let’s get into this week. We came in again Monday not really knowing with those new tariffs if the markets would be down or up, and futures were all over the place in the mornings. But the Dow finished up about 250 points. And Trump essentially mentioned that China called and wants to continue talking. And it was interesting because as the week went on, there was rumors that no, that that call never took place. Very strange, very strange. Some Chinese officials were saying, “We don’t know of this call.” But regardless, it boosted stocks that day.
Now, they were probably a little oversold, but it did boost the stock market, and it got me thinking, are we at a point right now, and Trump kind of alluded to it this week, President Trump, is this Trump put? Remember they used to call it their Bernanki put? In other words, any time the stock market would go down, they would say Ben Bernanke was there to lower interest rates and kind of bail the stock market out because he could essentially put a floor in a put, put a floor into the market. Is that president Trump now? And you think about it, he seems to know that he has the power to tweet something positive, to say something positive, verbally or on Twitter, and it gets the markets going up. And he kind of alluded to that fact this week when he said, “I can do a deal any time it.” It’s as if, again, it’s as if he’s waiting to do a deal until we get closer into the election cycle. Just speculating here. But it’s as if he’s the puppeteer right now and we’re all the puppets. It’s very interesting to watch. And so again, he comes out and says that, Monday, Dow Jones goes up 250 points.
Now Tuesday we got off to a very interesting start. Bill Dudley, who was president of the Federal Reserve Bank of New York from 2009 to 2018, so just came off the Fed, wrote an op ed piece for Bloomberg where he said, amongst other things, “Trump’s reelection arguably presents a threat to the U.S. and the global economy to the Fed’s independence and its ability to achieve its employment and inflation objectives.” And he went on to … Basically, he was essentially advocating further on in the article for the Fed not to bail out Trump. So this is very, very interesting and dangerous.
Here’s why, the Fed is supposed to be independent. Look at the data, they have a dual mandate, full employment, low inflation. That’s what they’re supposed to do. Not get into politics, not get into anything else, not worry about the stock market. But what happened was in this article he went on to discuss that the the global economy slowing down, and especially the U.S. economy is slowing down, because of president Trump’s tariffs and trade war. And remember, Chairman Powell has been saying that we’re lowering rates, not because the economy is so bad, but we’re doing it as an insurance policy against things deteriorating. Will, Bill Dudley is saying, “Look, we need to separate. President trump needs to be on an island.” In other words, the Federal Reserve, you guys don’t need to be lowering rates, bailing him out for his mistakes.
Now again, the numbers are suggesting lower interest rates. The economy has been slowing as we’ve been saying for months. It’s been slowing. The global economy has been slowing. They’re going to continue to drop rates. He’s saying, “Don’t cut rates, let Trump fail on his own.” So essentially, he’s saying that let’s throw six million people out of work, embrace the recession because we can’t be doing this with President Trump. Those are very dangerous words because it undermines the Federal Reserve’s independence. And there are others apparently inside the fed that feel the same way. Some believe that that Federal Reserve interest rate hike in December, which many believe was one too many, was done with some intention. You hate to believe that, but what Bill Dudley said is very scary. It’s because manipulating and getting political with interest rates, costs people jobs. Real jobs. It costs your portfolio, potentially. I mean, that sent shockwaves around the financial markets. It really did. It was very kind of surreal to read something like that, to be honest.
And this isn’t just my opinion. I talked to a chief economist at a very large firm this week who felt the same way. He said, “These were dangerous words and this has nothing to do with politics. You just don’t want the Fed making these types of comments.”
Now, Tuesday, all the talk was about small caps and the relative strength. They’re weaker and weaker and weaker. So large company stocks are outperforming small company stocks, and that ratio goes all the way back to 2003. So we’re seeing real weakness in small company stocks. They’re still down about 5% this month versus the market’s down about 2%.
Wednesday. This is another little interesting tidbit that came up. Google announced they are shifting their Pixel smartphone production from China to Vietnam. That production won’t come back and China knows that. China cannot afford for folks to start abandoning production there and moving it to Mexico, to Vietnam, South Korea, wherever. That is where America from the tariff standpoint has a leg up in this negotiation. Very interesting to see that because again, could that cause kind of a snowball? Will multiple companies start doing that? It’s not easy to move production out of a country to another country and they’re doing it.
Now, the Dow Jones was up 250 points as I mentioned Wednesday. Very strong day internally. We were down 130 at the open. But as I said at the intro, no news is good news. No news, a very quiet day and the internal is very strong. What was interesting is you started to see a broad participation, meaning value stocks, which have been really unloved for a while now. Participate, not only Wednesday, but Thursday.
Did you guys ever see The Big Short, or read The Big Short, the Michael Lewis book? Turned it into a movie. Good book. Great book. Good movie. I’d say the book was better than the movie, but very, very good. It was talking about the housing market bubble and the folks that benefited from the collapse of housing and how everybody thought it was crazy. Housing just doesn’t go down. Of course there was a bubble, too much lending, the story led to the financial crisis.
Well Michael Burry, who was a doctor and started trading for family and friends and essentially opened a hedge fund later on and lost a lot of people because he started betting and creating securities that would benefit from the housing crash, and literally went to these big investment companies and said, “I want to bet against that.” And they were saying, “We’ll take the other side of that deal.” And they would create securities. He was losing money month after month because he was early. Not wrong, but early. People were laughing at him, and all his investors were fleeing. He ended up making a fortune. I believe he closed his fund down and just does it as either a family office or something to that effect.
But he came up this week and said he sees a bubble in passive investing and he got mocked and ridiculed. I think he’s spot on. I think that the fact that you have some of the best mutual fund managers, asset managers of our lifetime, of our generation, in last five or six years have really struggled versus an index fund is concerning because if you look at some of the indices, and primarily just a handful of companies, they have been lifting the indices on their own while the cheap companies, the undervalued companies, the ones off the radar have struggled and there’s this bifurcated market which we’ve talked about for months. It’s continuing. I think when folks think they can just dump their money in and just constantly make money with not much risk, that’s a problem.
Over the long-term, diversification matters. Real diversification, not just an index fund and a bond fund. You have to have more than that. You have not needed it. Let me be clear. You have not needed real true diversification the last five or six years, and we are starting to see multiple signs of 401ks of investment shops giving up on certain types of investments because they have not worked, which is the wrong reason. 401ks are getting rid of commodity funds, for example. Just one example. Because they haven’t performed well. That is not a good reason. That is a buy sign in my opinion.
Now Goldman Sachs has a great picture. I’ll see if I can share it. Essentially what it shows is over time, there’s some things that outperform and there’s some things that underperform the Standard & Poor’s 500. It’s just normal, right? You’re going to get bonds underperforming or outperforming and international stocks underperforming or outperforming and real estate and so on and so forth. That goes on for a long time. There’s a clear line in the sand around 2013 where almost everything has underperformed the S & P 500. In other words, true diversification just has not worked. Part of it is this passive investing that Michael Burry is talking about. This guy is super smart and again, some are making fun of him.
It’s real interesting and we’re going to touch on kind of this passive versus active and really looking at growth stocks and value stocks in just a minute. Let me wrap up Thursday and Friday because that came up Wednesday. Thursday, Treasury Secretary Steve Mnuchin came out and said that issuing ultra long US bonds is, “Under very serious consideration in the Trump administration.” Possibly setting up a move that could mark a historic revamp of the $16 trillion treasury market 100 years was mentioned.
Now here’s the deal. You heard me literally two weeks ago talk about this and say, if there’s so much demand for our 10 year bonds and our 30 year bonds, why doesn’t the government issue 40, 50, and 100 year bonds? Why not refinance their debt longer, make our debt payments as a country lower while we can? Now you’re hearing about it now. Now, Steven Mnuchin had mentioned this months and months and months ago, but now that there’s demand, overwhelming demand and you’re seeing negative interest rates around the world, he brings it up again and 100 year bonds being mentioned. Now if you go, “Oh my gosh, who on earth would invest in a 100 year bond?” Look around the world. It’s happening now. It’s just not happening in the United States … Yet. Right?
Now Thursday, China said, we won’t immediately retaliate to the US tariffs. To me, what comes to my mind is, “On the next As The World Turns.” Or in any other soap opera you can think of. Because if you go back and look at all the articles for the last 18 months, they all say the same thing, which is, “Stocks rise as trade war tensions ease. Stocks drop as tariffs threaten the bull market.” I mean it’s back and forth and back and forth and both countries need to save face. Chinese New Year’s coming up. Big celebration. This is coming up October 1st so we have about a month where they’re not going to do anything prior to this. That has been talked about. They probably won’t. So they’re just going to puff their chest until afterwards and then maybe they will give in. They keep apparently wanting to maybe wait out President Trump. We’ve heard that, right? Let’s see if we can deal with somebody else in the new administration.
I don’t know if their economy can stand that. Again, companies like Google leaving, I don’t know if they can wait for that. President Trump on the other hand, he may not want to do this too quickly, but we know he watches the stock market and we’re still not much off of all-time highs. I mean we’re sitting at about, let’s call it a four and a half percent off of our 52 week high, all-time highs, for the Standard & Poor’s 500. Look, small caps are down 16% off their high. So they’re international. There’s other places that are down more. But my point is is that if we were down 10, 15, 20% he’d be getting a deal done. Right now he may feel like I don’t have to get a deal done. Let’s just keep seeing what happens. If it goes down a little further, boom, I can come out with a positive tweet and up we go. He is the puppeteer right now. Every time trade war worse, guess what happens? Money goes back into bonds because the economy would struggle under a extended trade war.
It’s just like a soap opera. It’s back and forth and back and forth. It’s like we’re in the middle of this washing machine getting sloshed around. Right? That’s how you feel. But in the big picture, we still haven’t had a tremendous amount of volatility. Nothing compared to December of 2018, nothing compared to that. But we have had some more volatility. Now we finished the week on Friday. Again, very quiet. As the week went on, it got very, very quiet. Again, there’s an upward bias to the market when we don’t have bad news. To me, no news is good news right now.
Now quickly, had a discussion internally to one of my guys about, it’s interesting if you look what’s happening right now. There is a big wedge where you have companies that are selling at ridiculous valuations. They don’t make a profit. Their revenue is going up,
But they’re kind of new. It’s like a new industry or new thing, and the revenue is going up but they make nothing and people were paying astronomical valuations for them. Then you have, on the other side of the ledger, companies that have been around for 50-75 years that aren’t growing their revenue very fast at all, but they’re cheap. You’re getting them at $0.70 on the dollar maybe and they aren’t going up like the other ones are. And it’s interesting because you start to hear excuses, “Well, those new companies, how do you value that really? You know, they’re doing some neat things and maybe they deserve a different type of valuation.” Doesn’t that sound familiar to you? Does that not sound like the 1990s tech bubble when people were making up irrational reasons and trying to be rational, but they were irrational about, “Well, you can’t value that company that way because it’s a new type of company and you can’t use traditional valuation metrics.”
That’s what leads to bubbles popping. And I think we have pockets of bubbles in this market. And I think Michael Burr is right, but here’s the good news is that there are still plenty of things out there, areas, pockets, sectors, industries, you name it, that are cheap and safe. So, it’s a matter of, again, knowing what you’re investing in. Now, here’s what’s interesting, though. At the end of the day, and I this could be an hour long conversation, but at the end of the day, to me, value stocks… And it’s all in the eye of the beholder, but value stocks are easier for you and I to invest in and research than growth stocks. Because growth stocks, in order for them to keep going up and up and up, it takes a lot more research because if that growth isn’t what it’s been doing in the past and it doesn’t exceed that, they get hit really hard, generally speaking.
On the flip side, I don’t care if a company has zero revenue growth. If you go in there and look at the books, look at their assets, look at what they owe people, what they’re supposed to get from people, you can put a valuation on there pretty easy. In other words, you’re not having to assume some type of growth metric, whereas with growth stocks, you do. Therefore, it’s very difficult in my opinion to really… If you’re doing individual stocks, it’s harder to do your homework on a growth stock than a value stock.
Now, which one’s which? There’s some blurred lines there sometimes because many people believe some of the growth stocks out there are value still. It’s all in the eye of the beholder, but traditionally speaking, value stocks are beaten up right now and they’re not hard to value. Growth stocks are difficult to value, and that’s just something to think. If you start doing individual stocks, if you’re doing your research… And most growth stocks, by the way, are kind of story stocks. In other words, they got some neat story behind them. You use their product, you go there to eat or what have you and so it makes sense, and you go, “Well, yeah. I use it, so it must be good. I’ll go buy it” without doing the homework necessarily to look at why is it going up? Is it just hype?
We have this chicken sandwich bull market going on right now. I kind of joked on Twitter this week that we have a blow off top potentially in chicken sandwiches. There’s a fight between Chick-fil-A and Popeye’s. Now, the company that owns Popeye’s, Canadian company, their stock’s gone way up based on all this hype. They’re sold out. They’re literally sold out. There’s cars wrapped around the building and there’s 20 people inside and they’re running out of chicken sandwiches, signs on the door saying, “We don’t have anymore.” Are they creating this buzz? Maybe. Is it going to hurt Chick-Fil-A? Maybe. But that is hype, right? It’s hard to buy stock when it’s gone up 50%, for example, because of this short-term phenomenon whereas hypothetically… Chick-fil-A is not public, but hypothetically, let’s say Chick-fil-A’s sales were flat, but we looked in there and said, “You know what? They have all these assets. They own all this real estate.” They have all these things and they’re selling it like 75-80 cents on the dollar. That’s an easier story to buy than to go in and buy a company that is going straight up based on short-term fast growth that may or may not last. There’s a lot of pressure.
And we saw this with Starbucks back in the day if you remember. Grow, grow, grow, grow, grow. And then when the growth just started to slow, they got hammered. Same thing with Whole Foods. Eventually, Amazon bought Whole Foods. This has happened to company after company that people are buying a trajectory and assuming this growth lasts forever and it just doesn’t due to the law of large numbers. So, if you’re buying individual stocks, really think about that. When you’re putting a portfolio together, very challenging to go research stocks in general. Most people probably shouldn’t be doing it at all, just it’s very difficult. But number two, what type of stock are you buying? Are you buying a story? Are you buying profits by the pound? And there are plenty of good companies out there that are profits by the pound currently and there’s plenty of companies that are hype currently.
Anyways, I hope that helps a little bit. We’ll kind of get into that a little more over the next few weeks because I think this market’s very interesting right now. I still believe at the end of the day we’re in a bull market based on all the technical work I do, based on all the looking at the internals, which were very good this week. And if you look at what happened coming into the beginning of 2018, a year and a half ago, foreign markets were doing well, US markets were doing well, and then the word tariff got introduced and ever since then, the market has basically moved sideways with more volatility. So, if we can get that removed and the uncertainty removed, I think we can also get the economy starting to pick back up because of the fact that we do have low interest rates. That is going to help a lot.
And in fact, something didn’t get noticed this week. It’s a kind of… Probably most people have never looked at it, don’t even know what it is, but the truck tonnage report. Go look that up. It’s at all time highs right now. 70% of the goods moved around this country are via truck. I mean, you want to see how the economy’s doing, you look at that and you look at gasoline prices for those trucks and the gasoline supply and demand for those trucks. That will tell you how the economy is doing and it does not look like a recession. So, for whatever reason, this recessionary fear’s popping up and it’s probably because we are getting a slow down, but a slow down is different than a contraction and a contraction’s different than a financial crisis. So, a very good report that came out this week, again, a new all time high and it’s very interesting. You could put that truck tonnage report on top of the Standard & Poor’s 500 and you get a pretty tight correlation. Very interesting to watch that. So, again, just one indicator, but a very good one.
Hey, just a reminder if you need our help, 210-526-0057. This show’s been brought to you by Covenant Lifestyle Legacy Philanthropy. And just a reminder, Sunday morning, 7:00 AM… Sometime around 7:00 AM, probably 7:15 or so, central standard time. On the CBS San Antonio affiliate, I’ll be talking about tariffs, trade war, kind of where we are, given all of the new information that’s been coming out. Hope you have a great Labor Day and take care, everybody. We’ll see you back here next week.
In this week’s edition:
· Financial Markets – Volatility continues, but credit markets are stable.
· Central Banking 2.0 – The extraordinary is now ordinary.
· Demography is Destiny – China has a population problem.
Last Week Today. Germany auctioned the first long-term, 30-year 0% coupon bond but demand was well below expectations, as the government only sold bonds valued at 884 million Euros vs. a 2 billion Euro target. Might this signal peak negative interest rate policy, in that the markets expect interest rates will rise sometime in the next 30 years and hence there are better investment opportunities than locking-in a negative return? | At the Jackson Hole soiree, Fed Chair Powell’s keynote speech was notable for what he didn’t say as much as what he did, in so much as he did not try to walk the market back from expectations of a rate cut in September. More on Powell’s speech in Central Banking 2.0, below. | Early this morning President Trump announced he had at least one phone call with China and they want to negotiate. China has not confirmed any requests occurred.
Financial Markets. In what looked like a nice bounce-back after three weeks of consecutive declines, equity markets unraveled on Friday. Fed Chair Powell performed well in Jackson Hole, soothing markets Friday morning, but in another episode of “He said, Xi said,” President Trump and China’s President Xi escalated the trade war once again via new tariffs. U.S. stocks fell nearly -3% on Friday, erasing gains for the week. Also, while international stocks were higher through Friday, that’s because their markets had closed before the U.S./China fireworks went off. As equity markets fell, bonds were bid higher, pushing some segments of the yield curve deeper into inversion. Putting aside the unusual shape of the yield curve, the 10-year bond is now yielding only 1.54%, leading to lower mortgage rates. Indeed, 30-year mortgage rates have moved lower from a peak of 4.8% in late 2018 to 3.75% today (Source: Bankrate.com), which should offer a bit of a tailwind for the struggling housing sector. For specific weekly, month-to-date and year-to-date asset class performance, please click here.
While equity markets have been volatile, and each violent decline brings another batch of pundits calling for a recession, credit spreads are painting a different picture. Corporate bond defaults characterize recessions as companies are unable to repay or refinance maturing debt. Hence, in advance of an economic downturn, risky bond prices generally fall (pushing yields higher) in anticipation of future write-offs. As the chart below highlights, the corporate credit market is not signaling an imminent recession.
Central Banking 2.0. In response to the Financial Crisis and the ensuing Great Recession, the major central banks adopted extraordinary monetary policies. These policies, designed to address slow growth and low inflation, were intended to be temporary but instead appear to be the “new normal” in central banking.
- Federal Reserve (Fed) – The Fed began normalizing monetary policy in October 2014 by ending QE3, and began raising interest rates in late 2015. Over the next three years, the Fed raised interest rates nine times, pushing the Fed funds rate up from 0.25% to 2.5%. The Fed also began to wind down its QE-bloated balance sheet in late 2017. However, the Fed cut rates in July and ended its Quantitative Tightening program early. More rate cuts are widely expected.
- European Central Bank (ECB) – The ECB adopted a negative interest rate policy (NIRP) on June 11, 2014, lowering its official deposit rate to -0.10%. The ECB cut rates three more times, and by 2016, the deposit rate was -0.40%. Last year, when the Fed was raising rates, the ECB suggested they would begin normalizing rates in 2019, but in light of slow economic growth have backtracked on those comments. Instead, the ECB is now proposing a continuation of ultra-easy monetary policy that will include a rate cut (deeper into negative territory) and a resumption of their Quantitative Easing (QE) program which began in 2018.
- Bank of Japan (BOJ) – The BOJ initiated QE in April 2013 and implemented NIRP on January 29, 2016, lowering its bank reserve deposit rate to -0.10%. The BOJ has never suggested an end to either policy, and since starting QE, the BOJ’s bank reserve balances have increased 738% from 42 trillion Yen to 352 trillion Yen in July (Source: Yardeni Research).
- Peoples Bank of China (PBOC) – While the PBOC has not delved into NIRP, it has pumped the economy with credit creation. Since 2008, bank loans exploded by nearly 400% from $4.4 trillion in December 2008 to $21.4 trillion as of July 2019. Keep in mind that in China’s communist, centrally controlled nation, banks (and bank lending) are controlled by the government via the PBOC.
In Central Banking 1.0, lower interest rates fueled economic growth and pushed inflation higher. In Central Banking 2.0, the bankers added extraordinary monetary policy measures to the traditional tools to combat persistently low inflation and economic growth. When the central bankers didn’t get the results they wanted, they applied more NIRP and QE and, as a result, the extraordinary has become ordinary.
Yet, the reality is that QE and low interest rates can only do so much in the aftermath of the Great Recession (and a lower “neutral interest rate”, the rate at which interest rates are neither restrictive nor stimulative). As Chairman Powell said in his Jackson Hole speech, “Low inflation seems to be the problem of this era, not high inflation” and as Europe and Japan have shown, negative interest rates and QE are not the solutions for overcoming low inflation.
The Fed is certainly aware of the ineffectiveness of Central Banking 2.0 and is not settling for a “stay-the-course and hope for the best” approach. Indeed, as Powell laid out in his Jackson Hole speech: We face heightened risks of lengthy, difficult-to-escape periods in which our policy interest rate is pinned near zero. To address this new normal, we are conducting a public review of our monetary policy strategy, tools, and communications—the first of its kind for the Federal Reserve. We are evaluating the pros and cons of strategies that aim to reverse past misses of our inflation objective. We are examining the monetary policy tools we have used both in calm times and in crisis, and we are asking whether we should expand our toolkit. [emphasis mine].
Demography is Destiny. From 1979 to 2015 China enforced a Malthusian family planning regime limiting families to raising a single child to control population growth and, according to the Chinese government’s logic, avoid nationwide starvation. The one-child policy resulted in the forced sterilization of women, late-term abortions, human trafficking in babies, and even the murder of infant girls to comply with the policy but raise a son. Indeed, the overall sex ratio in China became skewed toward males, and by 2016, there were 33.6 million more men than women (Source: Britannica). Forty years on from the start of the one-child policy, the legacy looms large as China’s demographic composition has transitioned from that of an emerging market (e.g., a high concentration of young people) to a developed economy (a la Japan), in which the elderly comprise the largest population demographic.
Indeed, below is a chart (click to enlarge) comparing the age-distributions of the populations in Japan, China, and the U.S. beginning in 1990 and as forecast through 2050. Which one is different? As the chart highlights, both China and Japan have fewer young people supporting their elderly population today, which over the next 30 years will only get worse (note how the pyramids become increasingly top-heavy in 2025 and 2050. Whereas, the U.S. population includes a much better and youthful composition over these periods, a portion of which is attributable to immigration.
Source: Business Insider
Facing the dire demographic effects of their one-child policy, in 2016, the Chinese government began allowing married couples to have two children. However, reversing the effects of a ruthlessly enforced 25-year policy is proving difficult. In 1979, just prior to implementation of the one-child policy, China’s women averaged 2.75 births each, but today it stands at just 1.62 births (meaning the average couple is not having enough children to replace themselves). Indeed, in 2018, China’s birthrate was the lowest since the People’s Republic was founded in 1949, with only 15.2 million births vs. the 21 million to 23 million births expected by the government.
The practical implications are numerous: a shortage of young adults to support the elderly; greater reliance on the government for housing, medical care, and food; a declining population and workforce leading to slower growth and higher labor costs. The latter effects are already evident as China’s official GDP growth slowed from 14.2% in the early 1990s to 6.9% today. Moreover, even before the Tariff War began, rising labor costs in China pushed companies to either relocate manufacturing back to the U.S. or source cheaper labor from countries like Vietnam. There is little China can do to change the demographics of their society except for implementing a two- or three-child policy (i.e., mandating parents produce more children) or adopting an aggressive immigration strategy to attract younger workers. Both measures are unlikely, and hence, the Japanification of China appears unavoidable.
Housekeeping note. Over the summer, I injured my shoulder, and I will have surgery this week to repair years of wear and tear. I’ll be in a sling for a good six weeks, so depending on my recovery and ability to type, I’ll be taking at least a two-week hiatus from writing the Weekly Synopsis. When I return, we will pick-up our Behavioral Finance series with an exploration of Cognitive Biases. We recently completed a six-part series focusing on Emotional Biases, which can be reviewed in the weekly synopses beginning with the June 14th edition. In the meantime, we’re working on bringing you new ways to access our material, including podcasts and videos. Look for an announcement and new content in the coming weeks.
 Malthusian: of or relating to Thomas Malthus or to his theory that population tends to increase at a faster rate than its means of subsistence and that unless it is checked by moral restraint or disaster, widespread poverty and degradation inevitably result.
On this week’s show, Karl discusses the escalation of the trade war and the impact on the stock market. Is it even possible for President Trump to “order” companies to move back to the U.S.?
Plus, all eyes were on Jackson Hole this week to try and get any clue from the Fed as to the next move regarding interest rates. Instead, all we got was confusion. Is any of their public speak helpful?
Welcome to Creating Richer Lives, where living a richer life goes beyond the balance in your bank account. In fact, it’s about what you do with your dollars and how the choices you make with your money, not only define your lifestyle now, but impact your legacy for years to come. Whether you’re working towards retirement or seeking ways to make philanthropy your goal, there is a road to get you there. It’s time to redefine what it means to have a richer life. Welcome to Creating Richer Lives. Here’s your host, Karl Eggerss.
Hey, good morning everybody. Welcome to the podcast. My name is Karl Eggerss. Creating Richer Lives is brought to you by Covenant. Lifestyle. Legacy. Philanthropy.® If you need more information, go to creatingricherlives.com. Don’t forget the website will continue to be updated. Pretty shortly, we’re going to be putting a lot more information on there. Audio, video, text, you name it. Keep you informed on what’s going on. A lot of financial planning, helping you become better investors and really accomplish your goals and help you with some of that through some of these tips. So using all of our collective resources, putting them on the site. I’m really excited about that. It should be coming in the next few weeks. So very excited. Stay tuned for that. In the meantime, continue to visit creatingricherlives.com and you can see the updates in real time. Don’t forget our telephone number. 210-526-0057. 210-526-0057.
Grab yourself a cup of coffee. This was a doozy this week as usual. It was a strange week. Was it not? We are seeing just, I don’t really know how to describe it. We’re seeing a tweet fest, which isn’t anything new in the last few years, but causing major gyrations in the market. So let’s do a quick recap on really what was going on this week in the financial markets and then we will get to what to or not to do about it. So Monday we got off to a pretty good start and the Dow Jones jumped 250 points about 1%. This really completed what I was looking for in a turnaround. Because remember the week before we had really overwhelming supply, meaning everybody, one-sided days, everybody’s selling. Get me out and I’ve always said what you look for is that followed by in pretty short order overwhelming demand. Get me back in. The prices are too good. I need some of that.
And we really got that. We got that on Monday. It was a very strong day. Kind of showed the capitulation and then it showed, followed by the overwhelming demand. So it checked that box. Good. Let’s move on. Let’s get this market going back up, right? Well not so fast. We saw the markets kind of trade down on Tuesday. Not real intense at all. Not a big day. Pretty light day as far as the news was concerned. And then we got some really interesting data on Wednesday. The Dow was up 250 points. So look, we were headed for a good week. Right? What was interesting was we had some good economic data. Existing home sales was good and more importantly I think we got two good reports, earnings reports from Target and Lowe’s. Now if those aren’t consumer oriented companies, I don’t know what is and remember we’ve had a good report from Walmart, good report from Lowe’s, good report from Target.
I will repeat the consumer is 70% of our economy and our thesis has been good but not great. We did not see and still do not see a recession, although we are more vulnerable today than we were a couple of years ago. But we still don’t see a recession and it’s very, very helpful to see that the consumer is still in good shape and we know that by looking at Target and Lowe’s as a proxy. So I thought that was a very good report. Now one thing that was interesting also that kind of went under the radar a little bit is Germany issued a bond, a 30 year bond with a zero coupon. What’s a coupon? A zero interest rate. You say, “Okay, I’ll lend you my money for 30 years. What do I get paid?” This one said, I tell you what, “We’ll pay you nothing and you’ll like it. ”
And guess what? Nobody liked it. It was kind of a flop. And maybe that’s the beginnings of people saying, “You know what, this negative interest rate world we’re in, this zero interest rate world we’re in, probably a not a great deal for my money.” And so we didn’t see an overwhelming demand for that. So we’ll see. You remember the week before you heard me talking about, I think there’s a high likelihood at some point we do see 40 year or 50 year bonds in the United States because the appetite has been so good, especially for US bonds. But at some point does this flip around? Now you guys that have been with me awhile and have listened and have seen, I’ve shown you, I’m going to describe it now, but I’ve shown you the bond market PE ratio. So remember in the stock world, you take the price divided by the earnings and it gives you a ratio and that determines how much you’re paying for a year’s worth of earnings.
Right? 15 times. 20 times, 10 times. Well, you can do it in the bond market, right? Because the bond market pays you so much interest on a bond, on a 10 year bond, guess how many years it takes back to get that interest if you invest that money? How many years of payments does it take to get back that money? The PEs around 63. 63. So the bond market PE ratio is about 63. so stocks are very expensive, especially relative, excuse me, bonds, take the back. Bonds are very expensive relative to stocks and that’s one reason why we think the stock market will continue to go up. But it’s been a fantastic year for bonds and it’s a great lesson in diversification because if you looked a year, two years ago, you said there was no way, and I’ve had people tell me there’s no way that you can make any money in bonds because the interest rates so low. How could you make any money?
Well, the reason you could make money is because the interest rates could go further down, which they have, which has surprised a lot of people. So bonds have had a fantastic year, a better year than the stock market and in a lot of different aspects, which is amazing. So that’s a good lesson in diversification. Now am I advocating for you to run out in an overload on bonds? Absolutely not. In fact, this is a really good time to look at the overall portfolio in terms of stocks and bonds. But don’t forget there’s a whole other category called other and that other includes real estate, private equity, other types of maybe lending commodities. Or just a tactical piece of some funds that move and investments that move differently than the stock market. There’s a lot of things that may have been up yesterday when the stock market was down so much and owning some of those things can really smooth out the ride.
And that’s a whole other animal. So let’s get back to kind of how we finished the week here because it was pretty quiet most of the week until we got to Friday. Thursday the market was up about 200 but faded after we had these hawkish comments by two federal reserve presidents at Jackson Hole. Remember Jackson Hole? They’re all getting together, going fishing, right? All these people talking about the Federal Reserve’s there, all these people talking about the economy and interest rates and they all go fish in the Jackson hole and they do this and they talk and guess what they do? They have CNBC there or Bloomberg or whoever, and they’re interviewing all these federal reserve presidents, some voting members and some not. Meaning some don’t have an impact on rates they just want their opinion. And some do literally vote if they’re going to cut rates or not.
And they’re interviewing all of these people and they all have different opinions and it serves no purpose at all. They should be muted, but they’re not. And it causes the market to go up and down. It causes there to be tremendous volatility and it really serves no purpose but they do it. And so two of the federal reserve presidents said, “You know what? We wouldn’t have raised rates in this last meeting and we don’t think we need to … or excuse me, lowered them and we don’t think we need to lower them again.” One of them said I wouldn’t have lowered them and I wouldn’t lower him again. The other one said I didn’t think we needed it, but I would went along with it, but I don’t think we need it going forward. That’s not what the market wants to hear. Wall Street likes lowering interest rates, you know that by now. So does that serve any purpose? Because if they really do lower rates in September, were those comments helpful to you? No, but that 200 point gain we had faded because of this public opinion.
And we also saw Thursday one of the manufacturing reports a little less watched than than ISM but a Markit manufacturing report came out M-A-R-K-I-T and it was below 50. First one we’ve seen that shows contraction. So again, some of these warning flags that the economy has been and is slowing and that doesn’t, that doesn’t surprise us. We’ve been saying that all along that it is slowing, but is it grinding to a halt and we don’t see that again because of the consumer, which holds the key. Watch the unemployment. Watch their wages, which unemployment’s been low. Wages have been up and watch to see are they spending or not. Now, Friday. Friday was the interesting day. We saw the Dow futures up around 100 points and the pre-market. We get a report that China says, Hey, we’re going to put on some more tariffs.
Whoa, where did this come from? We just heard Larry Kudlow on Thursday talking about we’ve had good meetings. So this took what seemed to be the president and his staff by surprise because they were in meetings all day and the market sold off about 150 points. But then Jay Powell came out at Jackson Hole with a speech that essentially was pretty dovish, meaning he left the door open to more cuts, kind of saw his mistakes in the last few months cause he’s had some blunders and the market recovered. It was up. Everything was going fine until mid-morning when president Trump tweeted and essentially said, “Hey, expect a response to this. These Chinese tariffs, these new round of Chinese tariffs. Expect a response from us later in the day.” That’s it. Market starts selling off because who knows what he’s going to say. And this was really interesting as well. He also responded by basically “ordering” American companies to come back home. Come back home. Make your stuff in the United States. I am ordering you to do this. As if he’s King.
It’s crazy. Well, first early in the week, obviously he said he’s the chosen one to take on China and then now he’s ordering companies to do this, which obviously you can’t do that. So the markets didn’t like that. And down we went about 600 points on Friday. So what was shaping up to be a reasonably good week ended on a very sour note. And then after the bill on Friday, we found out what most people probably thought is that he upped the tariffs a little bit. He bumped them up, put on a few new tariffs and so we are escalating the trade war. We meaning us, the United States and China are escalating. It’s going up and meanwhile the stock market’s taking the elevator down and that’s what’s happening.
Now, again, what does this do? Well, this trade war, which it is a trade war we’re still in negotiating back and forth, but the rhetoric goes up. They up the ante both back and forth and then you see it kind of market sell off. Then they kind of come back and say they had a productive meeting, they’re trying to work towards a deal and there’s a delay. I mean, we have seen this. I’m tired of talking about it and you’re probably tired of listening to it because it’s back and forth and it’s been this way for over 18 months now of the rhetoric increasing and decreasing and the markets going up and down. And again, they’ve made no meaningful appreciation really from the first time we heard the words tariff come out of president Trump’s mouth until now. We’ve had a lot of volatility, no meaningful progress.
And so, the longer this goes on, can we talk ourselves into a recession? Some people laugh at that and say that’s ridiculous. How could we talk ourselves into one? Well, I think we could. I mean if you just break it down, if those people, those same people that are shopping at Target and Lowe’s stopped doing that because they hear so much rhetoric and they hear so much fear and they stopped spending and their boss lays somebody else off because they’re worried about it, we could. We could talk ourselves into a recession. That could happen. So don’t think it can’t happen because again, a trade war is enough to shock the system. It’s enough to put us in recession. But again, I want to be crystal clear. Is there really a difference between a minus 0.001% growth rate or contraction in our GDP versus a plus 0.001% growth rate?
Because that’s the difference between a recession and not. A recession is two consecutive quarters where the economy went backwards. Not by how much, just it went backwards. You know, you taking one step back, two quarters in a row, are you really moving anywhere versus if you take one step forward two quarters in a row? No. But what we’re fearful of is really 2008, right? We’re all fearful of a financial crisis. We shouldn’t fear a recession even if it happened and we don’t see one right now. But you have that happening and then you have this, what’s really what I’ve called the inversion watch, which is every time the two year bond starts paying a tad bit more than the 10 year bond, the yield curves called inverted. Okay we know that. It’s been like that for a while now. Not officially, but every time it ticks up and it’s 0.001% higher than the 10 year people freak out, break in programming.
We’re inverted and then when it undoes it, okay, we’re not, everything’s okay again. Is that really the way the world works? Are you going to stop spending money based on that? No. You know, I mean all my friends, all the people I know that are CEOs are working for big companies. They’re busier than ever. Is the global economy slowing? Are there pockets in the United States slowing? Sure there are, but it does not feel like a recession to me. And furthermore, when we go to the stock market and we look at the stock market, we look at the supply demand figures, we are still not seeing any evidence of a bear market. Again, as we’ve said, corrections can come out of nowhere. I mean, we got the classic check boxes of capitulation two weeks ago and a turnaround Monday in demand.
We got that. We looked at the internals that looked really good, but none of that can trump Trump, right? A tweet from president Trump or something from China can overwhelm the markets in the short term. In the long-term it is about profits, and by the way this week, and this was something that didn’t get a lot of pub, but the leading economic index hit an all-time high going all the way back to the 60s. You’ve never entered a recession until that indicator has rolled over months in advance and it has not rolled over. It’s at a new high. Very, very important. Very important. And also let’s look around. So supply demand for the market looks good. Again, you’re seeing kind of a stalemate, which you can kind of feel. It feels like we’re just kind of sliding around in the mud, not going anywhere and that’s how it’s been and it’s that way.
There’s not a group leading. There’s not overwhelming demand for stocks and overwhelming supply of stocks. It’s pretty evenly balanced. It’s a tug of war where both sides have set the rope down and they’re just kind of staring at each other while the rhetoric is going on and on. We’re not getting any traction one way or the other. Therefore it’s important to be patient, not overtrade because again a tweet can change things. We can go to new highs very quickly and also be diversified. Because again, bonds have been your friend this year. Income oriented investments have been your friend this year. Gold has been your friend this year, right? Things that feast on volatility do well in this environment. That’s a well-rounded portfolio and again you are probably looking at the next 5, 10, 15, 20, 25, 30, 40 years for your money, not the next 5 minutes. If you did that money should be probably sitting around in the money market.
So that’s good that we have this supply demand still sitting there and again, we’re getting mixed economic signals, some weaker than others. They are weak, but there’s also some good ones coming out as well and building permits lately was good. That’s a leading indicator. I have to have building permits. That means they’re about to build something. They don’t have to build it, but they got the permit to. That’s a good sign, so we have some good stuff. You’re not hearing a lot of the good things. You’re hearing a lot of the fearful things and I’m not here to paint a rosy picture. I’m here to say let’s step back for a minute because there are still a lot of positive things going on. By the way, one of which lower interest rates. The interest rates plummeting right now are adding stimulus. There’s many research firms out there that see an economic upturn later this year because of the low rates. Gasoline’s cheaper. Interest rates are cheaper and again, let’s see if that shows up in housing, but the consumer should be in pretty good shape right now.
Now I will leave you with this. The tweet of the day, this came from Energy Credit One on Twitter. Funniest thing I saw and remember president Trump ordered I declare that these companies come back home and you will manufacture in the United States. So to his tweet Energy Credit One was Trump orders Panda express and PF Chang’s to immediately switch menus and serve only hamburgers, hot dogs and Apple pie. Classic, classic tweet. There’s some funny stuff on Twitter for sure. A lot of of course the president’s using Twitter in a lot of different ways and some good, some bad, but again, this is really, this week was not much different than what we’ve seen the past several months. I feel like if we can get past this and get, again, you’ve heard rumors and I mentioned them about a mini trade deal, something that just gets the nuts and bolts of it done, we could move on and keep this economy going.
And again, the longer it goes on, the more uncertainty there is, the more frustration there is, the more people start bailing on stocks. Companies start changing their patterns and you do get some manufacturing moving from one place to another. Those aren’t fast decisions, but if this keeps dragging on you might get that. So both sides have incentive to get it done. But there’s politics involved. There’s all types of things that go into this, but it certainly is a trade war and has been and that has not changed. And don’t forget a real value and something we do quite a bit is when you get this volatility in these markets, being able to quickly rebalance or cherry pick some things that you are under allocated in, if you were supposed to be in these particular stocks or mutual funds and the waiting has dropped or you have new cash, being very tactical and efficient in getting that invested quickly and buying dips if that’s your long-term goal is really important.
And most people don’t do that and it’s hard to do it because you’re kind of thinking, “Well I’ll just wait and see if I get a better deal.” But as I said, sometimes things can snap back very quickly. And we saw that. Again, had it not been for Friday, it was turning out to be a pretty good week and really the tariffs were interestingly enough, almost tossed aside. The market was positive until Trump retaliated. So again, as opposed to saying, “Let me talk to them over the weekend,” he said, let me increase the tariffs and again this is, this is negotiating. How do you negotiate? You don’t say, “You want to talk about it?” No, you say, “Here. I’ll up the ante a little bit.”
So we are seeing some collateral damage from that of course. And number one is volatility in the stock market. That’s what we see. But again, if you zoom out, if you were to go back 18 months and you just, again, I’ve said it, you fall asleep and wake up right now you’d say not much has happened in the last 18 months. But as we watch it day by day, minute by minute, and we get markets and turmoil specials on CNBC, as we get those things, it can drive you, number one, it can drive you crazy. Number two, it can drive you to make some really bad investment decisions. If you need help with those investment decisions, give us a call. 210-526-0057 and continue to go to creatingricherlives.Com. Have a wonderful weekend. We will see you back here next on Creating Richer Lives. Thanks for listening to the podcast, everybody. Take care.
Last Week Today. Argentina’s stock market fell by a remarkable -48% in U.S. Dollar terms (-30% in local currency) Monday after the current reform-minded president was beaten badly by his left-wing rival in primary elections. Keep in mind this is the same Argentina that, despite defaulting on its debt eight times in the last 200 years, was able to sell $2.75 billion of 100-year bonds to the market in 2017. | During Wednesday’s market sell-off of -3%, President Trump reportedly checked-in with the CEO’s of JPMorgan Chase, BofA, and Citigroup. The message from the bankers is that the consumer is in a good position, but trade tensions are hurting business confidence. | Speaking of trade tensions, in another round of “He Said, Xi-Said,” President Trump delayed the imposition of some tariffs until December, while China’s President Xi threatened to retaliate against the remaining tariffs scheduled for September 1st. | Japan jumped ahead of China as the largest holder of U.S. Treasury bonds ($1.1 trillion).
Financial Markets. Angst from a potent array of data points and tweets created another volatile week in the financial markets. Trade uncertainty, weak economic data from China and Germany, and a brief inversion in a critical portion of the yield curve buffeted markets as human investors and pre-programmed trading algorithms reacted forcefully to each new headline. Additionally, recession talk was everywhere this past week, from the newspapers to the radio, to the T.V., to the Internet (see the Google Trends graph below). If Charlie Brown were interviewed on CNBC, all of this doom and gloom would inevitably lead to one of his famous “Good grief” exclamations (I apologize to any of our Millennial readers as you’ll need to Google “Charlie Brown” to understand the reference).
Yet, for the second week in a row, the powerful daily ebbs and flows led to only modest declines in the major indices, such as the S&P 500 which ended down only about -1%, even as bond yields plumbed new lows. Indeed, new records were set throughout the week, including the German 10-year bund (the benchmark for European debt) reaching a yield of -0.73% on Friday; 45% of Investment Grade corporate bonds outside of the U.S. now trading with negative interest rates; the 30-year U.S. Treasury bonds reaching an all-time low of 1.91%. For specific weekly, month-to-date and year-to-date asset class performance, please click here.
Sometimes, But Not Always. Admittedly, the probability of recession is higher, but it’s not baked in the cake, even as financial T.V. pundits and their guests breathlessly discussed the yield curve inversion, over and over and over again. While it’s common knowledge that a yield curve inversion preceded every recession in the U.S., it’s not as well understood (or advertised) that every yield curve inversion has NOT resulted in a recession. In other words, the yield curve signal generates false positives. Moreover, the relationship between yield curve inversions and recessions is less pronounced internationally, arguing against the robustness of the signal.
There are also structural reasons why signals from the yield curve may not be as information-rich in today’s economy, which is a topic for another day. However, stepping around arguments for and against the quality of the yield curve signal, even if one believes this inversion will lead to a recession, good luck on timing it. According to Goldman Sachs, in the last five inversions dating back to 1978, recessions have started anywhere from 14 months to 35 months, with a median of 20 months, following the inversion. Investors should also note that following those five inversions, the S&P 500 rose by an average of 12% in the year following the inversions.
Nevertheless, fears of a recession, higher volatility, and favorable interest rates are causing investors to seek the safety of money market funds. Total investments in money market funds are now at levels last seen during the Financial Crisis in 2009. Now that the Fed is cutting interest rates, money market yields will no longer be as attractive, and investors will likely look for a new home for much of this money.
Source: Bloomberg LP and Covenant Investment Research.
Though a storm may be gathering on the horizon, there are legitimate rays of sunshine piercing the clouds that could prevent this slowdown from becoming a more severe situation, including:
Ray I. The yield curve inversion is a signal that monetary policy is too tight, an early warning sign that a recession is likely only if the Fed fails to react. The Federal Reserve is no longer ignoring the market signal of the yield curve. Nor is the Fed ignoring slower economic growth at home and abroad. While they haven’t admitted the December rate hike was a mistake, the Fed cut rates in July. To forestall further slowing, they’ll need additional rate cuts.
Ray II. Global central bankers are once again in a coordinated monetary policy easing cycle. The Fed’s interest rate cut in July provided cover for central banks overseas to cut rates to support their economies without the nasty side effect of potential capital flight from their countries.
Ray III. The consumer remains “in the game.” Comprising approximately 70% of domestic GDP, consumers continue to spend, pushing the economy forward. Strong balance sheets, low unemployment, and rising wages augur for continued support from this critical economic growth engine.
Ray IV. Lower interest rates are good for the housing sector. The recent decline in interest rates is leading to an increase in the number of mortgage applications and housing start permits. Housing has been in a pronounced slump for the past six quarters, but moderating prices, wage growth, and reduced borrowing costs are reasons for optimism that housing will stabilize in the back half of this year.
Bottom Line: The yield curve inversion does not a recession make. Risks of recession are higher, but they are no longer blithely ignored by the Federal Reserve or central bankers around the globe who are actively cutting interest rates to address the global slowdown. Hopefully, Fed Chair Powell will use his speech at the Jackson Hole Economic Symposium on Friday to clarify the Fed’s monetary policy strategy. Some will argue too little too late, but for now, we’ll take the other side of the argument.
How the Mind Works Against Successful Investing – Affinity Bias
(Entry #6 in a series on Behavioral Finance)
Most of us have faced this situation: When selecting wine at a dinner with friends, we default to a well-known, expensive bottle on the menu when a lesser-known (and cheaper) bottle would be equally enjoyable. Why do we do this, or why at least are we tempted to do this? You can probably guess the answer – the more expensive wine conveys status. Said differently, people select the pricier bottle not because of its functional benefits, but because of its image-related value. This tendency to make irrationally uneconomical choices based on our belief it will affect how others perceive us or the idea that the decision reflects our values is an emotional shortcoming known as Affinity Bias.
Humans are highly susceptible to Affinity Bias, and advertisers figured out long ago how to influence consumer behavior by exploiting this frailty. Consider Nike’s advertising campaign, “Just Do It.” Nike’s advertisements didn’t highlight the research and development that went into their apparel, nor did the campaign focus on the performance of their shoes and clothing. Instead, Nike used athletes and motivational slogans to associate their purchases with the prospect of achieving greatness. As a result, Nike successfully expanded the use of its apparel beyond fitness and transformed the brand into a fashion statement.
In the investment world, Affinity Bias leads to several errors, including the portfolio phenomenon of “equity home bias.” Home bias is one of the most pervasive and consistent characteristics of portfolios worldwide in which investors discriminate against foreign stocks, choosing to invest more in companies based in their homeland, regardless of the prospects for those companies.
While home bias is not fully understood, research shows that patriotism plays a significant role as investors favoring domestic stocks gain the expressive value of supporting the “home team.” Of course, in so doing, investors forego the practical benefits of diversification (to economic growth and currency exposures) that come from investing internationally. This phenomenon is not unique to the United States. The research paper “Patriotism in Your Portfolio” documents investor behavior in 33 countries, revealing that investors in highly patriotic countries are more likely to overweight their respective domestic stocks.
Consider your portfolio allocation relative to the U.S.’s contribution to total GDP. The U.S. economy is less than 25% of global GDP, but I bet U.S. stocks dominate your portfolio. There are other considerations such as economic growth, market liquidity, accounting reliability, etc. that are natural barriers to allocating a portfolio consistent with global GDP contribution, but clearly, there are good companies outside the U.S. that can improve a portfolio’s future performance.
In addition to favoring domestic stocks, Affinity Bias leads to the following investment errors:
- Purchasing stock in a company that produces a product you like. For example, suppose you own a Tesla or just like the look of the vehicles. Buying stock in Tesla (NASDAQ: TSLA) based exclusively on your feelings about the product does not make for a good investment thesis. Yes, famed investor Warren Buffett says to invest in products you know. However, I guarantee that Mr. Buffet will not invest in a company, regardless of his affinity for the product, unless he has a deep understanding of the company’s financial situation AND that the stock price is below his estimate of the company’s intrinsic value.
- Self-Imposed Peer Pressure. Investing on the basis that your friends or peer group have made the same investment. People who invest for this reason don’t want to be perceived as an outsider and therefore follow the group’s lead without doing their own financial research.
Addressing Affinity Bias begins with taking a step back and exploring potential influences on your decisions. In so doing, if you find you are overly concerned about what other people will think of your choice, rather than focusing on the merits of the investment, that’s a good indication you need to clear your head and start the decision-making process again. You can also disintermediate yourself from the decision-making process by consulting an advisor. Keep in mind that advisors are human too, so it’s essential to understand their decision-making process. It should be data-focused and include both quantitative and qualitative analyses to address the common shortcomings in the human decision-making process.
 Adair Morse (University of Chicago Booth School of Business) and Sophie Shive (University of Notre Dame), 2003.
On this week’s show, Karl discusses what the bond market is telling us regarding a recession. Is the bond market right? Karl explains. Also, there’s a bubble, but it’s not in the stock market.
Welcome to Creating Richer Lives, where living a richer life goes beyond the balance in your bank account. In fact, it’s about what you do with your dollars and how the choices you make with your money, not only define your lifestyle now, but impact your legacy for years to come. Whether you’re working towards retirement or seeking ways to make philanthropy your goal, there is a road to get you there. It’s time to redefine what it means to have a richer life. Welcome to Creating Richer Lives. Here’s your host, Karl Eggerss.
Hey everybody. Welcome to the podcast. My name is Karl Eggerss. Thank you very much for joining me. Just a reminder, this show is brought to you by Covenant, Lifestyle, Legacy, and Philanthropy. If you need help from Covenant, anything financial in your life, you can go to creatingricherlives.com. Our telephone number, 210 526-0057 and just a reminder, creatingricherlives.com will continue to evolve.
You know, over the years, you’ve been accustomed to me bringing you information in different ways, articles, podcast and audio, some video. We’re going to expand that and do more of that. We’re going to bring on more guests just like we did last week. Last week, we had a lot of positive feedback when we brought on David Akright, CFP to discuss the SECURE Act, which probably is going to affect almost everybody listening at some point, if it goes through.
So that’s something we’re going to continue to do. So over the next few weeks, continue to watch for that. We’re very, very excited about that. Well, let’s jump right in here. What an interesting week it was, despite all the gyrations this week. The S&P 500 finished down less than 1%. We’re still near all-time highs, but it feels much worse.
Why? Well, number one, the media, “800 point down day for the Dow Jones on Wednesday, the third or fourth worst point day ever,” something like that. Those are eye-catching headlines until you look at the percentages, and while a bad day, we’ve had a lot worse days than that over the years. But let’s get right into how we kind of got there.
Remember this started a few weeks ago, well really, this started in January, February of 2018. We’ve been going a year and a half now with this tariff talk and this trade war. That is a trade war and it’s been going on for a year and a half and we really have not made any meaningful progress in the stock market since, but a lot of volatility.
But this week it was more of what we saw last week, which was, kind of a, depends on what day and time you’re looking at the market to feel what kind of mood you’re in. You know, in other words, do you look at it at 4:00 in the morning, which I do occasionally and did. Futures are way up and then there’s a tweet or there’s a comment from a Chinese newspaper and all the sudden the Futures moved three or four hundred points.
But this all is about trade. That’s still the most important thing. Now, interest rates did get a lot of publicity this week, rightly so, but it’s still about trade. But Monday we come in and see there was an election in Argentina, didn’t go the way many thought. Their peso dropped 17%. Their stock market fell over 30% in one day. That’s not something you see very often.
And, of course, we have the Hong Kong protest shutting down the airport. Again, not a driver of our stock market, but certainly doesn’t help. But we started to see, the Trump administration said, “Hey, you know what? We’re going to hold off.” On, you know, Monday the market was down and then we come in Tuesday and the administration says, “We’re going to hold off. We’re going to hold off on the September 1st deadline,” that we heard about a few weeks ago.
And so the Dow went up 400 points, wasn’t the strongest rally in the world. In fact, we commented a little bit on that. That it didn’t have the oomph. It didn’t have, the internals weren’t that great. It just felt like a relief rally and that’s what it was.
And, Wednesday we get weak economic data out of China, weak economic data out of Germany and for the first time since 2007, yes, your ears are going to perk up when you hear that because anything… The first time since ’07, we go back to that financial crisis and say “What was going on then?”
The first time we had a yield curve inversion on the twos, tens they call it on the street. Now before you turn off the podcast, what does that mean? Well, all that simply means is treasury bonds in the U S that are two year maturities are paying more than a 10 year maturity. That’s not normal.
And the problem with it is that when it inverts like it did, it’s called inverted, it sometimes leads to recession, not all the time. That’s key. Not all the time, but sometimes, and it did it this week. So naturally the naysayers, the recession people, the bears are coming out saying, “Aha, we’re going into recession.”.
And the economy continues to slow. We’ve been saying that. We’ve been saying it’s good but not great and it’s slowing for months and that hasn’t changed, but let’s not extrapolate and assume it’s going to continue to go down, down, down.
Why can’t it just turn around later in the year? It very well could. And even so, this is the other thing, you look at when this yield curve inverts and everybody’s panicky, and by the way the Dow Jones was down 800 points, which is about 3% on Wednesday. If you look at the stats, the stock market is typically higher a year later when you have that inversion.
And in a recession, even if it does occur, it doesn’t occur for several more months. All recessions have been proceeded by a yield curve, but not all yield curve inversions have led to a recession. So you might have to hit the rewind. I’ll repeat it. All recessions are proceeded by a yield curve inversion. So when you have a yield curve inversion, it doesn’t necessarily lead to a recession. But we’ve never had a recession where you didn’t have that.
And that’s a big distinction. So just because we have a yield curve inversion does not mean we are guaranteed and destined for a recession. Is it more likely? Yes. Is the economy susceptible to shocks and potentially recessing? Yes. Are we overdue for a recession? Yes. Are recessions normal part of the economic cycle? Yes.
But we saw the Dow fall 800 points. It was a 90% down day. That essentially means it was an all or nothing day. It’s the second one we’ve had. We talked about one the prior week. When you get those capitulation days, what you look for, and for those of you that have been listening 10 years plus, you know what you look for is, that’s scary, but you got to see the other side. You got to see the demand side pretty soon. You got to see the intense buying.
And we saw a good day on Friday. We saw a good high quality day. But it, you know, we’re not getting these 90% days. But could we get, you know, some good days strung together? Yes. And that’s good. So you need to see after the, get me out, you need to see the panic buying, trains leaving the station. And that’s usually, signals the bottom. And we saw it in December and we talked about in December and we saw it in early January. We got that combination.
So Wednesday was a big day and then Thursday more volatility, more trade news, up and down because you know this report came out, this report didn’t come out or did from another source on trade. And then Friday, of course, we did get the solid day really on no news. That was a big driver. So the Dow Jones finished up about 300. So for the week, we did see the markets down less than 1% after that crazy ride.
By the way, many of you asking how my voice is doing, you can tell it’s not 100% but it’s a heck of a lot better than it was a couple of weeks ago. So I will continue to sip my coffee. You do the same.
Now here’s what’s interesting, we heard late Friday, that there’s two things that jumped out. Well, number one, we have negative interest rates and in my estimation, a big bond bubble happening. I mean, bonds are being bought like there’s no tomorrow. So the U.S. Treasury, late in the day on Friday said, and this was a report that came out from Bloomberg, “The U.S. Treasury to do market outreach again on ultra-long bonds.”.
Remember there’s countries around the world that are doing 100 year bonds. Why not? I would say, why not? If the appetite for our bonds are so good for 20 year bonds and 30 year bonds and 10 year bonds, why wouldn’t you refinance that and go out a 100 years?
Why wouldn’t you do that? If I could give you a 50 year mortgage for not much more, think how much lower your payment would be. Who wouldn’t do that? Now, those of you that are opposed to debt, may not do that. But if the demand for our bonds are that good, why wouldn’t the Treasury do it. So this is something that looks likely that we would have 40, 50 year treasury bonds. Could we have 100 year bonds? Maybe. Every other place is doing it in the world.
So that was a late, interesting little report coming out late in the day on Friday. We also saw yesterday that apparently on Wednesday when the market was falling, President Trump called three bank CEOs and they briefed him about what was going on. This is interesting, right, because we’ve heard this before. The markets, I mean, imagine if this was ’08, the stock market fell 37% in one year. It fell 50%, around that, approximately from it’s high.
We’re down 3, 4, 5% off our high and he’s calling in executives to brief him on what’s going on. It’s pretty clear what’s going on. The economy’s slowing. The Fed is dropping rates now. They can’t fix everything. They’re trying. He’s hammering them, and we have a trade war going on.
So a trade war and an economy slowing and confidence falling, yeah, the market’s going to be a little volatile. I’m actually surprised it’s holding up as well as it is, given all that. But if we continue to get progress and there is continues to be rumors of a mini-deal, a partial deal, you know, excluding the intellectual property and the theft, if we get a mini-deal and not a comprehensive deal, that could be enough to keep us going in the right direction.
Earnings have been okay, but this bond situation is fascinating. These bonds look like tech stocks in the 90s. They’re going vertical, so, you know, that’s going to juice the economy in and of itself. People continue to borrow for real estate projects. I have friends that are CEOs, that are telling me and they’re in very industrial type of businesses saying, “Things are still hopping.”.
Now, some of that could be geographical, but the point is, is that those low interest rates don’t hurt. But we still don’t see any signs of a recession yet. And again, when you have some of these little warning signs, stock markets, the statistics show, there’s several sources out there showing that the stock market has done very well over the next 12 months when we’re in these same conditions.
So step back for a minute and exhale, because again, if you get too pessimistic here, you know what can happen. You get days like Tuesday, Dow up 400. You get days like Friday, Dow up 300. Things bounce back.
Again, quality as we move along, knowing what you own is very, very important. Not only knowing what you own in terms of quality and there’s good deals out there right now, also avoiding things that are not good deals, and having a diversified portfolio, including things that may not have done well the last couple of years.
You know the things that have not done well are things that could do extremely well going forward. Return chasing and getting out of things that haven’t done well in the last couple of years and getting into the things that have done the best is one of the worst things you can do. And be very careful about doing that and that’s what a lot of 401k investors do. “Well this fund’s done very well.” Well it has, but that doesn’t mean that you get to buy those old returns. You get to buy the forward returns and you don’t know what it’s going to do.
So look at the strategy and see if it makes sense. And again, it’s part of a comprehensive plan, which speaking to that, switching subjects here, this is interesting, I had an email from a client who in his 401k, you ever log into a 401k and it, kind of, has this little calculator like, “Hey, we know your salary because you work here and you’re this age.” And it tries to do some kind of light retirement planning without knowing anything else about your other assets. Well, we have a client that has all of his 401k money, which is a small, small part of his net worth, is all in stocks.
And he got a letter, an email from the 401k provider, automated, of course, that says, “Greetings,” doesn’t, say “Salutations.” “Greetings. During recent plan reporting, it was determined that a number of planned participant’s equity allocation in the 401k is at a point that is considered quote, age aggressive. You have been identified as part of that population and we are reaching out to you to inform you of this.”.
And it talks about, “You should go to our website and put a portfolio together that makes sense.” Do they know that this is a small portion of his 401k, like his advisor knows? Do they know that he has kids in college? Do they know that he gets stock options given to him? Do they know that his wife works or does not work? Do they know any of this stuff? No. They don’t know anything. They’re using one of the dumbest tricks in the world, which is age to determine your risk.
I know people that are 100 years old and 100% stocks because they don’t need the money. They’re investing for the next generation. And this is the type of information, now, fortunately, he sent it to us and said, “Hey, look at this I got.” And we said, “Yeah, we know you’re a 100% stocks in your 401k or the majority of stocks because guess what? All the stuff outside of your 401k is more conservative.” Do they know that? No, they don’t know that.
The problem is when people get these emails, they dialed it back because the age aggressive, and now their allocation does not match what it should based on their plan. Because this 401k Consulting Company, they’re not doing any financial planning. The little calculator on their website doesn’t help. So be very, very careful about this. When people don’t know the full pie, they’re just looking at a puzzle piece or a pie piece. They’re not getting the whole picture.
And this is why it’s important to work with a financial advisor that knows your situation and knows the last three years, five years, 10 years, what’s been going on with your family, knows your income, knows what your legacy goals are and knows your risk. To use age as a risk barometer is silly. It always has been. That whole thing about 100 minus your age is how much percentage you should have in stocks. You know, if you’re 80 you should only have 20% stocks, without taking anything else in consideration is ridiculous.
So, careful with that. And I had never seen this before. This was a new one. I had not seen somebody emailing saying, “You’ve got the wrong allocation, based on your age.” So be very careful because your 401k has to be allocated in conjunction with your IRAs, your Roth IRAs, your joint accounts, your trusts, your family, limited partnerships. Put all those together. That’s how you start putting an allocation together. The 401K’s just a piece.
All right, everybody have a wonderful weekend. Another cup of coffee going down the shoot for me. Don’t forget 210-526-0057, our website creatingricherlives.com and our sponsor is Covenant. Thanks and have a great weekend, everybody. Take care.
Last Week Today. The trade war between China and the U.S. showed the first signs of conflating into a currency war when China allowed its currency to fall through 7 Yuan to $1 for the first time in eleven years, sparking a global equity market rout on Monday. | China’s provocation prompted the U.S. Treasury to label China a currency manipulator, a label that has little legal teeth, but which many feared was a preliminary step towards the Treasury devaluing the Dollar. | Japan’s leading economic indicators fell to their lowest level since 2009, increasing the risk the country falls into another recession. | As the Hong Kong protests continue, China sent an ominous message, “Those who live by fire will die by fire.” All protesters will be punished, a spokesman said, including behind-the-scenes instigators, giving rise to concerns the Chinese government will repeat the mistakes of Tienanmen Square in 1989.
Financial Markets. Stated simply, it was an erratic week. Not that you would notice if you only looked at where equity markets closed week-over-week, which was rather staid. However, if you were watching intra-week, every day seemed to bring new market-moving headlines, and investors were confronted with gut-wrenching up and down moves daily. The opening salvo came on Monday when China allowed the Yuan to trade through 7, prompting an intraday decline of nearly 1,000 points in the Dow Jones Industrial Average, that only partially reversed by the day’s end. The S&P 500 and Nasdaq followed suit, declining almost 3% for one of the largest single-day losses in the last ten years – see the illustrative chart below, which was making the rounds on social media.
It did not get much calmer as the week wore on, as a bounce in asset prices on Tuesday, was met with a fresh round of selling Wednesday morning. The multiple selling impulses in equities provoked massive bond-buying in a bid for safety from the storm. Indeed, flows surpassed the highs in the tumultuous fourth quarter of last year and at one point on Wednesday, the 10-year UST bond yield touched 1.59% (the lowest level since just before the Presidential election in 2016).
As one would expect during such wild swings, volatility woke from its slumber, and the VIX Index jumped 39% to 24.6 in a single day on Monday before falling back to end the week just a hair under 18. Yes, it was a fitful week. In the end, however, equity index losses were modest, while the yield curve shifted downward, flatter, and into deeper inversions.
For specific weekly, month-to-date and year-to-date asset class performance, please click here.
Breathing Room. Take a look at the asymptotic price increase in the chart below. No, it’s not Bitcoin or a graph of Beyond Meat’s stock. It’s the price of a 30-year Austrian Government Bond. The value of these bonds increased by 64% in the last seven months and now yield only 0.25% per year. While an extreme case, it’s representative of the move in global interest rates since the Fed signaled they would cut rates, which, in turn, allowed central banks around the world to follow suit.
Sources: Bloomberg L.P. and Covenant Investment Research.
Indeed, last week alone New Zealand cut interest rates by 0.5%, India cut 0.35%, and Thailand cut 0.25%. Some have characterized the actions by central bankers as a “race to the bottom,” implying there is a competitive motive between central banks to reduce interest rates. This view is an oversimplification that largely misses the point. Central bankers are merely undoing the rate increases they were forced to implement to protect against capital flight when the Fed was raising rates. For many of these countries, interest rates had reached a level restricting economic growth. With the Fed reversing course to lower interest rates, these countries now have breathing room to reduce their rates, which should help stimulate growth.
What if a trade deal is not the objective… for the U.S. or China? The latest tit for tat between China and the U.S. reminded me of a piece I wrote back in October, summarizing two economists views of why a trade deal was not necessarily in the U.S. or China’s best interest. Thus far, the economists’ predictions are coming true, and the piece is worth re-reading as a near-term resolution to the trade war is increasingly remote.
How the Mind Works Against Successful Investing – Regret Aversion Bias
(Entry #5 in a series on Behavioral Finance)
Have you ever met someone who could not make a decision, even when they had all of the available data? Sometimes this situation is referred to as “paralysis by analysis,” but the underlying behavioral science shows that typically these individuals are anxious they’ll regret whatever decision they make. When people are afraid their decision will be wrong in hindsight and avoid taking decisive action, they are exhibiting Regret Aversion. Regret Aversion can be toxic because it often causes people to hesitate most in the precise moments that require assertive action.
At its base level, Regret Aversion emerges when people are seeking to avoid the emotional pain of regret that comes from poor decision making. Unfortunately, Regret Aversion boxes people into a corner as they try to avoid two types of mistakes that, when taken together essentially cover any decision they make:
- Errors of Commission occur when people decide to do something, and the result is suboptimal. For example, selling their stock portfolio in March 2009 after already incurring losses of greater than 50%.
- Errors of Omission occur from inaction leading to lost opportunity. For example, not selling high-flying technology company stocks in 2000 when analysts were inventing new valuation metrics to support their thesis that stocks would move higher (remember when the number of viewers’ “eyeballs” on a tech company’s website were considered more important to corporate valuations than profits?).
Interestingly, Regret Averse investors are more likely to commit Errors of Omission than Errors of Commission. In other words, Regret Aversion tends to show-up as inaction because, with Errors of Commission, the investor takes action and feels a greater sense of culpability for the result. But, in committing an Error of Omission, the investor takes no action and is more likely to view the outcome as opportunity cost. The emotion of regret is decidedly stronger for the results of actions taken than for the results from inaction.
Investors suffering from Regret Aversion often commit one or more of the following mistakes:
- Investing too conservatively – Risk is an inherent part of investing, and in seeking to avoid reasonable risk levels, investors may see subpar growth in their portfolio that jeopardizes their investment goals.
- Staying out of the market after a loss – Fear is high following significant market declines, but this is often the best time to buy as stocks valuations are lower.
- Holding onto investment positions too long – This happens with losing positions when the investor fears the stock price will recover without him. This also happens with winning investments when the outlook has changed, but the investor is afraid of missing out on further gains.
- Preference for good companies – Investors often try to reduce their fear of regret by investing in household name companies, even when the prospects for lesser-known stocks are better. Illustrating this point, an old saying on Wall Street was, “You’ll never get fired for investing in IBM.” While that statement may have been right, IBM wasn’t always the best investment option.
- Herding behavior – Investors often believe they will feel less regret if they invest in what is considered the consensus. Herding can lead to dangerous asset bubbles that ultimately end in tears (e.g., the Dutch Tulip Mania of the 1600s and the more recent Dot-com Bust).
Regret Aversion is a particularly tricky behavioral bias, because those that suffer from it continually find themselves in a “Damned if I do, damned if I don’t” predicament. Similar to other Behavioral Finance biases, knowledge is power, and awareness of the types of investment mistakes that result from Regret Aversion is the first line of defense. However, for some people, Regret Aversion is simply too powerful to overcome, and it leads to suboptimal investment decisions. For these people hiring a professional asset manager is an important step to getting their financial plan back on track.
On this week’s show, volatility has returned due to the ongoing trade war. Karl gives all the details. Plus, David Akright CFP, joins the show to discuss the SECURE Act. If it passes, will you be impacted?
Welcome to Creating Richer Lives. Where living a richer life goes beyond the balance in your bank account. In fact, it’s about what you do with your dollars and how the choices you make with your money not only define your lifestyle now but impact your legacy for years to come. Whether you’re working towards retirement or seeking ways to make philanthropy your goal, there is a road to get you there. It’s time to redefine what it means to have a richer life. Welcome to Creating Richer Lives. Here’s your host, Karl Eggerss.
Hey, everybody, welcome to the show. Thanks for joining me. We appreciate it. As always. Again, this is Creating Richer Lives. I am your host, Karl Eggerss. Laryngitis is maybe 50% better than it was last week, so again, I will have my coffee. You get your coffee and we’ll do this together. Hey, just a reminder, the show is brought to you by Covenant whether you need help with lifestyle, legacy or philanthropy Covenant is there to help. Go to creatingricherlives.com, and our telephone number, as usual, 210-526-0057. Hey, as we mentioned over the past few weeks, we want to continue to give you more and more information, really help you in all areas of your financial life.
And with that being said, we’re going to bring on a guest here in a little bit. David Akright is in studio. He is a Certified Financial Planner with Covenant, and he’s going to be talking to us about the Secure Act. What is that? It’s in Congress right now. Is it going to get passed? What does it mean for you and your retirement? We’re going to ask him some of those questions coming up in just a few minutes, but first, what a week it was, huh? We come in on Monday and we had a little bit of selling, of course, two weeks ago, but we come in on Monday.
A little bit of retaliation from China regarding trades, so not only are we in a trade war, we’re in a currency war now with China. They’re manipulating their currency. They’re called a currency manipulator, which is funny because every country’s really a currency manipulator when you really get down to it. But we walk in, the Dow Jones is down about 500 at the open and the selling continued. It was down 900 points at one point during the day, kind of bounced back, but still was down 750 points, and you see on TV, “Oh, my gosh, this is the sixth-largest Dow point drop ever,” right? The media pumps that up.
But in terms of a percentage drop, there’s been over 400 daily drops that were bigger in percentage terms. So bad day, a 3% down day. But we have seen worse throughout, and so remember, this China trade war continues to escalate and it is a chess match. And so China announced they’re going to stop buying US agricultural products and they said being labeled a currency manipulator would severely damage international financial order and cause chaos in the financial markets. And so investors didn’t like that. And look, there’s a pattern here going all the way back to January of ’18, anytime tariffs are mentioned, anytime trade escalates stock market sells off, or essentially have been flat the last 18 months with extra volatility and that seems to continue for now.
Now, Tuesday was not the interesting day. Monday, of course, we got the big down day, 90% down day. That’s pretty much everything across the board, “Get me out, everything’s down.” So you would expect some type of bounce back Tuesday and we got it. The Dow Jones was up about 300 points, but it was a weak bounce. Generally, when you see these all or nothing days, I call them, where everything’s down like Monday you might get another one of those. We saw that in the fourth quarter of 2018. That should be followed pretty quickly with tremendous demand, A 90% up day, “Get me in, I don’t want to miss it. The market’s going to get away from here.” And we saw two of those types of days after the December 24th kind of peak in selling back in 2018. This bounce we got on Tuesday was a weak bounce. And we also heard on Tuesday that we had over $15 trillion now of negative-yielding debt.
So you look at country bonds around the world, various countries, $15 trillion of that has a negative interest rate on it. So think about that. Now, there is also a very tight correlation with that and gold. If you notice gold going up lately, you put the chart of the negative-yielding debt on top of gold. It’s moving very closely. So if you think that trends going to continue, gold could continue to do well and vice versa. Now, Wednesday was perhaps a more important day than Tuesday because you get a bounce after a horrible day like Monday, you get a bounce back. Wednesday though had every chance to fall and it was down, the Dow Jones was down 500 at one point roughly, but finished fairly flat on the day. So that was interesting because you could stall some buying come in, and then Thursday we had a really strong day. The Dow Jones was up 370 points and a consistent day.
So now you’ve reversed the weekly losses in just a couple of days. Interesting to watch that, so that was very important. So there’re still buyers there and it had to do some with currency, some just got … There was a little more less tweeting going on probably regarding trade. And then Friday, kind of another day it was down about 260, 280 points or so, bounces back, actually goes positive and then finishes down just a little bit. So for the week, again, we finished less than 1% down on the major indices, but a volatile week nevertheless. But here’s what’s interesting. We’ve had a 5% drop now, not quite 10 yet from the high. And this is the 25th time since March of ’09, which was the low after the financial crisis, the 25th time that we’ve had a 5% correction.
And Charlie Bilello has a great quote saying, “They all felt like the end of the world at the time,” and that’s true. They’ve all felt like that. So here we are. By the way, interesting to watch. A few days ago, the day the market was down and reversed late in the week, we did start to see bonds really go parabolic. People piling into bonds, interest rates plummeting and everyone’s screaming, “This must mean we’re in a recession,” and we put out our mid-year commentary on the economy here this week, you can go check it on our social media. But we don’t think that we are entering a recession. We think the markets are slowing. Rates will stay fairly low, but it’s still a good but not great economy and it is slowing. And we’ve been saying that I’d been saying that too on this podcast for what seems like months.
Now, having said that, interest rates went down to a low that really is it’s a 10-year treasury going down to 1.6% approximately felt very panicky. People panicking buying bonds and at some point, and we saw it intraday, a few days ago, at some point people start to take profits in bonds, short bonds and I think you’re starting to see that, and when that kind of stabilized stocks seem to stabilize. So bottom line is is that the bond market is acting as if we’re definitely going to recession. That’s how the bond market looks. I mean remember late 2015, early 2016 similar thing happened and the economy was slowing at the time too and it wasn’t technically recession, although it kind of felt like one at the time. This is kind of the same thing. It’s slowing down but we don’t think we’re going into recession based on everything we’ve seen.
So given that, bonds are pretty expensive at this point and probably due for a pretty good pullback even from a trading perspective. But if we look at what’s going on for the year right now, we still have good gains in equities across the board. Really the only laggards are going to be energy and financial, excuse me, healthcare is lagging a little bit, but energy’s really the spot that we need to watch. We need to watch oil prices because again, kind of a proxy for what’s going on in the economy to a certain degree. We do have geopolitical risk, we obviously have other supply-demand issues going on, Saudi Arabia, et cetera, but we need to watch that. We need to watch copper and see what’s going on. And so bottom line is though we don’t see a tremendous amount of inflation, but the consumer, who is over two-thirds of the economy is still in good shape and that’s really, really important.
So for right now we got a little oversold, probably not the fat pitch just yet, but again for those that are sitting there with a tremendous amount of cash, this is a time to look because you get these opportunities of two, three, 4% down sometimes and you can take advantage of it. But as I mentioned for the year, bonds are doing well, gold’s doing well, stocks are doing well. A lot of things across the board are doing pretty well this year and despite the sell-off, we’re still very close to all-time highs. All times a long time. We’re only 3% off the high. When you look at the S&P 500, roughly.
By the way, I wanted to mention, there’re some interesting stats going around that when you see interest rates fall as fast as they fallen, those who think we’re in going to enter recession and therefore we have to have the stock market fall take a look at the statistics. When you have the interest rates false fast as they fallen recently, most of the time the stock market going out one month, three months, six months, nine months, a year is higher based on a lot of evidence. So generally that’s a good thing when interest rates are falling for the stock market because again, what’s the whole point? Why is the Fed even doing this? They’re trying to grease the wheels. They’re trying to make sure that you continue to borrow
And that real estate developers continue to borrow, and that keeps the economy going. So the stock market generally react positively to that. All right, enough about the market. Let’s move on to our interview. All right. As promised, I have David Akright, who is a advisor with Covenant, and he’s been researching and looking into this SECURE Act, which if you haven’t heard is, it stands for Setting Every Community Up For Retirement Enhancement Act of 2019, which is quite a mouthful, so leave it to the government to come up with a long acronym.
But this was introduced a few months ago, and once again, I will apologize for my voice, as I’ve been having some issues the last couple of weeks, but we will go through this. And fortunately, you’ll get to hear David talk more than myself.
Karl Eggerss: David, welcome to the podcast.
David Akright: Yeah, I appreciate you having me, Karl.
Karl Eggerss: Folks know that we wanted to… This podcast has always brought people information, and the idea is to bring them the most relevant information, and really information that’s going to impact them. And this SECURE Act, which isn’t finalized yet, is something that really will impact pretty much most everybody concerning their investments and planning. And so why don’t you just kind of briefly give us the background of what the SECURE Act is, kind of where it is, and not necessarily where the odds are of it passing, but if it does go through, what does this look like for the listener?
David Akright: Sure, yeah, absolutely. As you mentioned, what it stands for is Setting Every Community Up For Retirement Enhancement Act. So it has mostly to do with retirement, and a lot of the different savings vehicles that people are using when it comes to retirement. This is actually a piece of bipartisan legislation, which is actually pretty encouraging. I feel like we don’t hear that often out of Washington.
Karl Eggerss: Very rare, very rare.
David Akright: Yeah, so it’s good. Currently as it stands right now, it has passed through the House, almost unanimously. And so it’s currently in the Senate. But from what I hear, most people expect it to pass almost as it’s written today. Maybe a little bit… A few tweaks here and there.
Karl Eggerss: You think if it does, is it something slated for voting in 2019?
David Akright: That’s right, yeah. They do expect it to be signed into law by President Trump at the end of the year. Now that could always change, but that’s what signs are pointing to right now.
Karl Eggerss: And then would it go into effect in 2020?
David Akright: It would.
Karl Eggerss: Okay.
David Akright: Yeah. That’s how it’s written today. So it would start in the beginning of 2020.
Karl Eggerss: So what are some of the main highlights? Because obviously the name implies that it’s trying to help people for their retirement. So is it?
David Akright: Yeah, I think for the most part it is. Yeah, I’ll touch on just a few of the highlights of the piece of legislation, as it’s written today. So the first part is, is more access to employer plans. Most Americans, they save for retirement in their 401k plan, that’s how most people build up their retirement savings as they’re working. And so what this bill is trying to do was make them more accessible for all employees, and employers as well too.
David Akright: 401k plans can be somewhat costly on an administrative cost. And so it may deter small businesses away from using these 401k plans. One of the parts of this bill is making it more affordable for small businesses to set up these 401k plans. So there’s a small business credit to help defray some of the startup costs for these 401k plans, so I think that’s generally a good thing.
David Akright: Another thing is that in terms of automatic enrollment, so this is something that’s become more and more popular, is as employees start, they’re automatically enrolled in that 401k.
Karl Eggerss: It’s like an opt out, as opposed to an opt in. Yeah.
David Akright: Exactly, exactly. And I think for the most part, people don’t opt out. I think a lot of times 401k’s are thought of as just set it and forget it. And if your contributions are automatically going in there, and they’re invested based on your risk tolerance, and everything like that, you may wake up one day and be glad that you didn’t opt out.
Karl Eggerss: Sure, sure.
David Akright: So I think the really positive pieces of this bill has to do with these 401k plans.
Karl Eggerss: Okay.
David Akright: Yeah.
Karl Eggerss: Good. So there’s been a lot of talk about something, I believe it was probably in ’96 or ’97, as far as I can recall, when stretch IRAs or inherited IRAs came in. Prior to that, somebody dies, father, mother dies, kids inherit the IRA and they had to distribute it, and pay all the taxes, bump them up potentially into another bracket, high bracket. And in the late ’90s, that changed, and they allowed a stretch, which essentially allowed the child, we’ll call it in this example, to stretch those distributions out over their lifetime.
David Akright: Correct.
Karl Eggerss: Something’s changing with that if this bill goes through.
David Akright: That’s right. Yeah. As you mentioned, so let’s just as an example, let’s just say, a 30 year old inherits an IRA from their parents.
Karl Eggerss: Right.
David Akright: So the second one passed away, the 30 year old inherits it. They got to stretch that out, maybe over 50 years, based on their lifetime.
Karl Eggerss: Sure.
David Akright: And so they’re benefiting from a lot of tax deferral of that inherited IRA. And so in order to pay for this bill, they established what’s called the elimination of the stretch IRA. And so what that does is once you inherit an IRA from a non-spouse, you are required to fully distribute that IRA within 10 years of inheriting it.
Karl Eggerss: Which again, dependent on somebody’s age, like you said, you could have been stretching this out over 40, 50, 60 years potentially.
David Akright: That’s right.
Karl Eggerss: So that is a big deal. But what that does, like you said, to pay for it, IRS gets their money faster to help fund the benefits of this SECURE Act.
David Akright: That’s right. And I think the reasoning behind that is the IRS does not view an inherited IRA as a retirement vehicle. They want you to actually distribute that money, pay taxes on it, and then go spend that through consumption, which will ultimately help boost the economy. That’s the thought there. But they don’t want that to be a retirement savings tool for people. They want that to be, pay taxes on that and consume it.
Karl Eggerss: Which rarely does an IRA fully get… I mean, it’s supposed to distribute based on their life expectancy. That’s what the required minimum distribution actuarial tables are based on is somebody’s life expectancy. So it’s supposed to be exhausted theoretically by the time you die. Because it grows over time, rarely do you see that, but that is the principle behind it. So changing the stretch IRA to 10 years is one of the key components. What’s another one?
David Akright: Yeah, so I think more of a positive one is that most people know that you have to start taking your required minimum distributions from your IRA accounts once you turn age 70 and a half. Well,
that was established decades ago. And so actuarial tables have changed since then. So they’ve made a modification that, if this were to pass, that RMDs would actually start at age 72 now.
Karl Eggerss: Which makes sense. I mean, you’re going to see probably social security, the normal age, full retirement age go up. You should be seeing this go up as well, but to your point, people are living longer, but that 70 and a half was put in decades ago.
David Akright: Sure, sure. And top of that is once you reached age 70 and a half, you were no longer allowed to contribute to an IRA as well too. They’re also going to take that away. Because it’s not uncommon to see people working past age 70 and a half, and if they’re eligible to contribute to an IRA, that’s something that they’re… They want to encourage people to continue to save for retirement.
Karl Eggerss: Sure. No, that makes sense.
David Akright: That’s another piece of that legislation.
Karl Eggerss: Yeah. I see you have something with 529’s, that you had mentioned, or we talked about kind of off before the show started. How does this impact 529’s? Which are of course a pretty big educational savings plan, very popular one.
David Akright: Yeah. So with the new tax law that went actually into place in beginning of 2018, they expanded what a 529 can be used for. Before it was only secondary education, and with the new tax law that’s already in place, it allowed it for K through 12 education expenses.
Karl Eggerss: Sure, private schools.
David Akright: Correct. Up to $10,000 per beneficiary. And so they’re just expanding that a little bit more, and they’re allowing it for homeschooling as well too. So it just is expanding the use of that savings tool.
Karl Eggerss: IRAs, pretty much that was the 70 and a half going to 72 and a half, or 72?
David Akright: 72.
Karl Eggerss: 72. Stretch IRA coming down to 10 years, 529’s, what else is in this act as far as a big highlight?
David Akright: Well, yeah, I think just going back to that employer plan, they want to make it a little bit simpler. Some of the safe harbor rules that can get fairly complex, in terms of when you can contribute and things along those lines, they’re trying to simplify that a little bit more.
Karl Eggerss: Again, the crux of it is to make things better for retirees.
David Akright: Sure.
Karl Eggerss: But as you said earlier, it has to be paid for in some way and that’s where the stretch IRA comes in. From a planning standpoint, obviously the goal of this podcast is to educate people. Our new podcast title is Creating Richer Lives. And that can mean a lot of different things to different people. So from a planning standpoint, what are some things to think about with this potentially coming into play in the next few months?
David Akright: Sure, yeah, that’s a great question. And I think there’s going to be a lot more planning opportunities as it pertains to this piece of legislation. And really to kind of quickly summarize it, is it makes the IRAs a less valuable estate planning tool.
David Akright: I’d say just as a general rule of thumb, the larger the IRA, the more it’s going to be effected by this piece of legislation. Because the larger the IRA, generally the wealthier an IRA owner can be. And so there tends to be more that’s passed down to their children, once they inherit an IRA. And so the larger that balance that they’re inheriting, the more that they could be subject to taxes, and even some protection from that IRA money as well too.
Karl Eggerss: Well, and again this is why we emphasize planning so much because this dramatically changes the game for large IRAs. Especially in an inherited situation, to have to distribute it over 10 years, versus a lifetime. That’s going to impact a lot of people, and so projecting out potentially what your taxes might look like, your cash flows, very, very important. And again, the more you plan, the more you can try to reduce those taxes, try to accomplish what you want in a more efficient manner.
David Akright: Exactly. And so I think really, it probably should go without
David Akright: But a lot of the planning opportunity is going to take place while the IRA owner is still living. Once they pass away and it’s been inherited, there’s some planning in terms of how you distribute it out within that 10 years, once you’ve inherited the IRA. But for the most part, the bulk of the planning is going to be done while the IRA owner is still alive.
Karl Eggerss: Right. I mean one thing we do a lot of is Roth conversions when people retire and they don’t have any income. They go, oh my gosh, I don’t have any income. And we go, this is great you don’t have any income. If you have assets saved up, there’s a lot of things that can be done with that and the timing of that. But how much you do is critical, because you can do too much, and obviously bump you in another tax bracket. So again, it all goes back to planning.
David Akright: Yeah. And I think Roth conversions is going to be one of the more important planning opportunities as it pertains to the Secure Act.
Karl Eggerss: Now we did hear prior to President Trump being elected, there was talk about elimination of the Roth, or probably a grandfathering, you know the ones that were in place stayed. That’s not in here.
David Akright: That’s not now.
Karl Eggerss: And I mean have you heard any talk about that? Because it’s such a great tool, especially inside of 401ks, by the way.
David Akright: Correct. So there hasn’t been any talk about that as it pertains to the Secure Act. Now the elimination of the stretch IRA would also apply to Roths as well too. So it will have an effect there. So if husband and wife have a Roth IRA and they both pass away and child inherits that Roth IRA prior to this legislation, or as it is today, you could stretch the Roth IRA out over your life.
David Akright: And so that’s a long time period of tax free investment performance. And so with the elimination of that, and you have to distribute it within 10 years, it will go away. Now there’s still not going to be any taxes due when you distribute it, because that’s the benefit of the Roth IRA. But now it’s sort of getting pulled out of that tax-free Roth wrapper, if you will.
Karl Eggerss: Yeah. No, that’s an excellent point because it’s very critical. So what else from the planning side should people be thinking about? I mean, is there any prep, if we know this is … let’s just say it was going to go through January 1st, 2020. anything people need to be doing now or thinking about now? Obviously talking very general, we don’t know people’s specific situations, but what things should people be thinking about? Other than obviously circling back to that financial plan, and maybe once we know this goes through to update the plan and take some of those things in consideration.
David Akright: Sure, yeah. I’m always going to caution people to not do anything too serious until it’s actually signed into law, because a lot can happen between now and then. But it’s good to be aware of, and that’s the point of this particular discussion. I think a lot of the planning opportunities today, you know, we mentioned Roth conversions, I think you’re going to see a lot more of that. If somebody’s in their 70s and 80s and their income is much lower because they’re no longer working, they may have some social security and they’re taking RMDs and things like that, but they could be in a much lower tax bracket today.
David Akright: And once you distribute out of the IRA, you’re locking in that lower tax bracket compared to what your children when they inherit it, they may still be working and in a higher tax bracket and things like that. So I think you’re going to see a lot more of of Roth conversions. Again, I would probably wait until it’s signed into a law before we started doing that, but-
Karl Eggerss: And there was a misconception regarding Roth conversions versus contributions, not to go off on a tangent, but I actually had a question this week from a client who said, am I even allowed to do that? I said, yes, you’re allowed to do that. The contributions is where they look at your income, et cetera. Conversions, not so much. So yeah, again, you can do some planning around that.
David Akright: Yeah, exactly. That’s a great point, because I’ve dealt with that before too, when can they do a conversion. And so it’s much more liberal on when you can do that versus a contribution. Another thing I’ll point out is how your charitable contributions, how you deal with those with your IRA. It’s pretty common to see clients use their IRAs as a charitable gifting tool. So you can either do what’s called a qualified charitable distribution. Once you’ve reached age … well it’s 70 and a half now, it’s going to be 72. Once you’ve reached that age, you can make donations directly to a charity from your IRA account and it won’t be counted as income.
Karl Eggerss: And there are limits to that, but essentially what you’re saying is, somebody’s given their church X dollars per week. They potentially could not do that in a year, use their distribution that was already going to be taxed to them. It goes straight to the church and neither party pays taxes on it. It’s a very efficient way … and from a cashflow perspective, you get to keep that cash that you were giving to the church. Everybody wins except the IRS.
David Akright: Exactly. Yeah. And another benefit that I often bring up is it reduces your adjusted gross income when you do that. And oftentimes, things like Medicare premiums are tied to your adjusted gross income. And so this is just a great way to just directly reduce your AGI. So there are other benefits of that as well too.
Karl Eggerss: Yeah, but again, see if you take these things in isolation without a comprehensive plan, you wouldn’t see that, what you’re talking about. You would say, oh, I know I have this benefit in isolation, but you know, you need to take in consideration your social security income, your capital gains, your Roth conversions. Put it all into the hopper and go, oh, I see if I, if I move this dial, it has a direct impact over here, either positive or negative. And that’s when you start optimizing it.
David Akright: That’s exactly right. And even on top of that, things that we’ve been talking to our clients about is with the increased standard deduction, we see prior to … when the standard deduction was much lower prior to this tax law, with charitable contributions and no cap on property taxes, things like that, it was pretty unusual to see a client using the standard deduction. Especially in Texas when property taxes are higher than other states.
David Akright: And now that there’s a cap on 10,000 on property taxes, and deductions … certain, or got phased out and things like that. We’re seeing more clients utilize a QCD, a qualified charitable distribution, for their charitable contributions and now using the standard deduction. So there’s some tax savings to be had there as well too.
Karl Eggerss: Could somebody do the QCD if they were 50 years old?
David Akright: No, they can’t.
Karl Eggerss: No, they got to be-
David Akright: Exactly.
Karl Eggerss: This is to replace the RMD essentially.
David Akright: Exactly. That’s a great point.
Karl Eggerss: Required minimum distribution.
David Akright: That’s right. And another thing with as it pertains to charity, is you can also leave a charity charity as the beneficiary of your IRA as well too. So if you have husband and spouse, spousal rollovers are not changing. So if you know husband passes away, it can be rolled over to the wife’s IRA, and she takes RMDs based on her life expectancy. So the Secure Act does not change any of that. It has to do with, now that non spouse beneficiary. And so by leaving it directly to a charity, that’s money that you got a deduction on when you put it in the IRA, and now it’s going directly to charity from there.
Karl Eggerss: A lot of people listen and do have trusts set up for various purposes. How are trusts impacted, or at least people with trusts, should they be thinking about that right now? Should they be changing anything?
David Akright: Yeah. Again, I would not recommend you go out and change any of your legal documents right now because that can get expensive, obviously. But if the Secure Act does pass, which it’s looking like there’s a good chance that it will, there’s going to be some impact as it pertains to a trust being an IRA beneficiary.
David Akright: So in today’s current tax law and as it’s been in the past, it’s not uncommon to see an IRA being left to a trust for the benefit of children, for many different reasons. You know, often it’s a spendthrift issue, you want to have trust protection. There’s also some creditor protection benefits from the trust as well too. And so long as the trust was written correctly as an IRA beneficiary, it would actually look through, and RMDs required distributions were based on the oldest beneficiary’s age.
David Akright: So again, if it’s a 20 year old beneficiary of the trust, it can be stretched out over 50 years. Well, now with that stretch going away, and you have to make those distributions within 10 years, trusts really aren’t as effective of an IRA beneficiary.
Karl Eggerss: Yeah. No, that makes sense. So again, I mean … and people should be checking their beneficiaries every year. This may force some of those people that had trusts on their … and maybe they don’t even know, they did it years ago, to update that. And of course all of this should be updated yearly. Your trust, your beneficiaries, [crosstalk 00:30:36] your plans. Yeah, precisely. And oftentimes, you know when the government does introduce some bill, there’s domino effects. And some of it’s for some people’s benefits, some of it’s detrimental to them, but it does take more planning.
Karl Eggerss: So, appreciate you joining us, David Akright, who is a certified financial planner with Covenant. Thanks for coming in and talking about this, and we’ll have you back soon.
David Akright: Yeah, appreciate it Karl. Thanks so much.
Karl Eggerss: All right. And everybody else, don’t forget, creatingricherlives.com is the new website. We will continue to add more and more things to that particular site. So thank you for joining us. If you need our help, (210) 526-0057. Have a wonderful weekend. Take care, everybody.
In the second quarter, only two sectors of the economy contributed positive growth, and deteriorating trends suggest our “Good but not great” growth outlook for the economy will come under pressure in coming quarters. Slowing growth is one reason the Federal Reserve has shifted toward easier monetary policy, but importantly, U.S. central bankers are also responding more reasonably to slowing global macroeconomic conditions and persistently low inflation. With the Fed actively easing, our baseline forecast does not include an imminent recession, but the call is increasingly difficult to make as slower growth produces a fragile economy more susceptible to shocks.
Creating Richer Lives is the new podcast, brought to you by Covenant. On this week’s show, Karl introduces the new show and what you can expect to hear in the weeks to come.
Welcome to Creating Richer Lives, where living a richer life goes beyond the balance in your bank account. In fact, it’s about what you do with your dollars and how the choices you make with your money, not only define your lifestyle now, but impact your legacy for years to come. Whether you’re working towards retirement or seeking ways to make philanthropy your goal, there is a road to get you there. It’s time to redefine what it means to have a richer life. Welcome to Creating Richer Lives. Here’s your host, Karl Eggerss.
Hey everybody, welcome to the podcast. My name is Karl Eggerss. Unfortunately, the big debut of the new podcast, Creating Richer Lives, comes with little bit of a cost, it is you having to listen to a laryngitis voice. Now, I almost didn’t do the show and I said I’m going to power through. My voice is good enough to do the podcast, so I’m going to do it. I’m going to attempt to do it, so bear with me. There will be some throat clearing, a lot of coffee, but there’s so much going on right now and so much to tell you that I couldn’t not do the show. So here we go. It’ll sound at times like perhaps going through puberty, but I’m not, I’m a grown man.
But yeah, welcome to Creating Richer Lives. This is going to be a podcast that very similar to what you’ve heard in the past. However, we’re going to add a lot of new features, probably more interviews in a lot of different areas. We’ve done interviews over the years on the Eggers report in the past and they were just few and far between. So I want to do a few more interviews, bring on some experts in the fields of financial planning, tax planning, the state planning, all areas trying to help you live a richer life. And what does that mean? I mean, obviously when you hear a richer life, you think, great, these guys are going to try to help me make more money. And certainly, we want to do that, but we also want to give you a better lifestyle and it’s really choosing what you want to do with the money that you create. And that can be, obviously it could be taking care of a an elderly parent, it’s making your life richer.
It could be anything, educating your kids. And what you do with your money is really your choice, right? You can use it for your own benefit and do whatever you want to do, whether it’s travel, or going to nice restaurants, or just spending time with family. It can be given it away, right? The legacy part of it. It can be given it away and we’re going to help you over the next several months, teach you ways to do that. And it can also be giving it away to not only your kids and grandkids, but it can also be giving it away to charities and being philanthropic with your money.
And then the last thing is what we’re going to try to help you reduce, if we can, is the tax part, right? We can always give our money to the IRS, we choose not to do that, as little as possible, obviously we have our taxes to pay, but there are ways to reduce your taxes, and we’re going to try to help you do that. So that’s what this podcast is all about, is us really helping you create that richer life. And that’s what we’re going to do.
So, having said that, go to creatingricherlives.com that’s the new website and you will see the podcasts on there, and we’re going to beef it up over time, you’ll see more content on there, but we wanted to launch this so you would have a place to go to listen to the podcasts and get some more information. So, please do that, creatingricherlives.com.
Now, I’m really powering through with this voice. Let me take another sip of coffee here. So, we did have a very important week, very, very busy week. We had not only the Federal Reserve, which everybody knew they were going to cut interest rates at least a quarter of a point. Some people hoping for a half a point, but a quarter point was already baked in, they’d pretty much said they were going to do that, they did that. Market didn’t react much to that until the press conference when Jerome Powell, the head of the Federal Reserve comes out and says, “Hey, here’s the deal, this is a mid cycle cut, this is a case by case situation,” and of course I’m paraphrasing, but he gave the impression that it may be a one and done. Like we did this and we’ll see how it goes down the road. Instead of, yes, this is the beginning of a rate cutting cycle.
The market in Wall Street and investors did not like that comment and stock market went down very quickly because remember, the United States, all the countries around the world are addicted to low interest rates, cheap money, and we’re seeing that. And so, that comment caused the stock market to sell off.
Now, what’s interesting is I thought it was silly because they’re still going to look in six weeks and assess the situation and probably do it again. And so, you saw the next morning the stock market went back up and was up about 300 points, the Dow Jones, until president Trump said more tariffs are on the way as of September 1st because China is not holding up their end of the bargain. They said they would do this and they’re not. They said they’d do this and they didn’t that. And so, they are not living up to their end of the bargain, therefore come September 1st, we are going to implement more tariffs. So the Dow fell about 300 points.
Now, remember it was up about 300, so it had about a 600 point swing on Thursday and then of course on Friday more selling down at about another hundred. So for the week what we saw was, we saw the Dow Jones down about 2.6% the S and P up down over 3%, we saw growth stocks get hit, we saw the Nasdaq down about 4%, queues down over 4%, emerging markets down 5%, small caps down 3%. So selling across the board.
Areas that did very well bonds, gold did very well for the week. In fact, if you look at the things that made money last week, treasury bonds, gold, gold miners, real estate, corporate bonds, housing stocks made money, utility stocks, your usual suspects. But let’s think about this for a minute, what’s really driving the market right now? Is it the fact that the Federal Reserve only cut interest rates a quarter of a percent? Some believe we should’ve had an element of surprise in cut, they should’ve cut by a half a percent and really caused the market to go, wow, we wanted that, We didn’t expect it, but boy, what a surprise the market goes flying up. Others believe that they should not have cut rates at all because the economy is not heading into recession, therefore they shouldn’t have cut.
Honestly, at the end of the day, it’s more about the tariffs than it is about the interest rates right now. And you could see that because the market didn’t do much, it went down a little bit the date of the interest rate cut because of the comments, but then it rebounded and was up really nicely on Thursday only to sell off once the tariffs kicked in. And if you look at a chart of when president Trump has implemented these tariffs, that usually begins the sell off. It happened in January of 18, happened in the fall of 18, it could be happening now. So watch the tariffs because that seems to be what’s driving the market a little more than interest rates.
Now I did send a picture internally to a couple of folks on our investment committee earlier in the week and saying, you know that volatility index looks like it could spike very soon, had that little picture, the curling up a little bit, and boy did we get it. We got about a 45% jump in the volatility index this week.
And what about interest rates? Interest rates on a 10 year treasury have dropped to 1.85%. Bonds are very, very overbought, but they keep going up, right? Overbought stuff can keep going up. So this is where, again, having a balanced portfolio makes sense because most people would believe interest rates would be much higher. The bond King, Jeffery Gunlock, it said interest rates were going to be much higher, he’s been completely wrong on that because they’ve been going down. I’m not picking on him. A lot of people have, but it’s a good lesson in diversification because if you say bonds are not a good deal, I’m going to only own stocks. Bonds have been doing very well this year and continue to do well.
So that’s a balance approach, but they’re over bought right now, probably going to pull back a little bit [inaudible] but look at interest rates across the world. Interest rates across the world are becoming more and more negative. Germany is supposed to be one of the best in Europe, their interest rates are negative across the board from one month maturity all the way out to 30 years. Unbelievable, negative interest rates. We’re seeing it spread. Could it happen here? Why not. That we would probably have bigger problems if that happened here, but we’re certainly headed that direction and it’s something we’re going to have to watch.
Now the areas that get hit the hardest, obviously interest rates were down quite a bit, steel stocks down 8%, right? Right in the cross hairs of tariffs and so forth. Metals and mining down 6.5%. Oil and gas stocks got hit. Semiconductors down 6%. Regional banks, and why would banks be getting hit? Remember they are profitable when they can lend at a higher rate and borrow at a low rate, and right now it’s compressing. They’re not getting a big spread. So they’re getting hurt. Retail down 4.5%.
So there’s a lot of damage across the market right now. Are we in the middle of a sell off? So far, the answer would be yes, but remember we had not had even a 10% sell off in 2019 and we typically have 13% to 14% sell offs at some point during the year, and we have not had that, so we’re due for a sell off. In this script, the last year and a half has been tariffs, whenever tariffs flare up and a trade war flares up, the stock market sells off. You combine that with interest rates when the Fed was tightening and stock market sells off. Now the feds loosening and the stock market’s still selling off, which tells you this is about tariffs, the script is the same.
If we go into late August and a deal is not, market continues to sell off more than likely. However, if we see progress, because this is a threat about September tariffs, if they get some type of progress, remember that’s all we need right now, some continued progress on trade. I think the market rebounds. And remember we’re in our estimation, we’re still in a bull market, okay. We are still in a situation where the economy, not only in the US, but around the world is slowing and it looks like it’s going to continue to slow. We don’t see a recession on the horizon based on our consensus view, but we do see an economy that is good but not great. We’re getting mixed signals, but there is a slowing going on and because of that many believe this slowing is going to continue to lead to lower interest rates and therefore you can continue to own bonds.
That doesn’t mean you don’t own stocks, it just means that the interest rates spike that everybody was thinking may be delayed. My thing is we have to look at the behavioral side of this. If everybody agrees on something, you know what happens. We could get an interest rate spike just because everybody’s leaning the wrong way and it separates from the fundamentals. So let’s continue to watch that. I’m going to spare you the rest of this podcast with my voice. It is deteriorating as I speak, therefore, I’m going to cut it short.
But just keep in mind that right now what’s going on is the tariffs are probably leading the way for the stock market. Again, watch the action on Thursday, market was recovering fine until the tariffs, so let’s continue to watch that. There’s a lot of rumors about this trade war and the timing of the election. Is Trump trying to maybe perhaps delay this trade deal knowing he may have one in his back pocket until closer to the election or is he trying to … some people say he did this right after the Federal Reserve because he’s trying to force the Fed’s hand to cut rates, because remember, the Fed said, “We are cutting rates partly because of the trade war.” So Trump wants lower rates. He’s begged for it. He’s criticized the Fed, he’s criticized Powell, he did it again this week. If he exacerbates the trade war, could that lead to lower rates?
I don’t think that’s the reason he’s doing this. I think it’s because China is not doing what they said they were going to do and he’s getting impatient and he knows tariffs are the way to get them to give in. And again, I’ve said I don’t like the tariffs. You hear about costs going up, right, on various things. It’s going to be a tax for you and I, but nobody else has offered a solution. Tariffs do seem to work to get China to always come back and give in on some things. So, we’ll see how that goes.
Next week, God willing, my voice will be better and we will do a more in depth podcast and we’re very excited about Creating Richer Lives, hope you are too. We’re going to have on just a lot of guests and do some really fun things that will hopefully help you create a richer life for you and your family. So, don’t forget creatingricherlives.Com. Our phone number is the same. You can always email me or call me, (210) 526-0057. if you or anybody you know does need help, we are here to help you, that’s just for a conversation and you can always email me as well, but just go on to creatingricherlives.Com. All right, have a good weekend. I’m going to go have some more coffee. Take care, everybody.
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