Eye on the Markets - 2019


Weak Economic Data and Trade Wars

By Ketu Desai

Before I discuss markets, it is important to discuss a SEC settlement with 79 investment advisors. These advisors steered clients into higher cost products for their benefit, at the expense of their clients (I have linked SEC press release with full list of firms). Unfortunately, such behavior is far too common in the industry. The core issue is that many investment advisors continue to not act in the best interest of their clients and often have competing interests. Cases such as this is precisely why i-squared was created. i-squared aims to bring honesty, transparency, and integrity to wealth management. At i-squared, alignment of interest and putting the client first are core values. The next time you meet with your advisor ask if he/she is invested alongside you. At i-squared the principal is invested with clients, we are in it together. i-squared does better when clients do better. i-squared is an independent fiduciary that is not affiliated with a large firm that might try to push you expensive product (that you most likely don't need), it simply wants to help you grow your wealth in a customized, thoughtful, and responsible manner. At i-squared, lowering your total cost of investing is important, from underlying expense ratios, taxes, to transaction costs. At i-squared, clients have full transparency from the portfolio to the fees they are paying.

www.sec.gov/news/press-release/2019-28

The primary story for markets this year continues to be the push and pull of supportive central bank policy with weak economic data. The dovish policy announcements from central banks continued this month. As expected, the ECB announced a restart of its TLTRO program, which provides ultra-cheap loans to its banks. The Fed continued its dovish pivot, as the meeting in March indicated that the Fed does not expect to raise rates in 2019, and only expects to hike once in 2020. The Fed also announced it will begin tapering its balance sheet roll-off in May, and end the program in September. As central banks have turned dovish, yields across the globe have collapsed. Long rates in particular have come in quite significantly, causing portions of the yield curve to invert, note that the important 10s/2s spread is not inverted. An inverted yield curve has preceded recent recessions. It is important to note that while the yield curve has inverted prior to recent recessions, not every inversion has predicted a recession. Further, the yield curve needs to be inverted for some time, not just a few days for reliability. While an inverted yield curve is not a positive development for equity investors, it is important to keep a few things in mind. Financial conditions are loose, credit spreads remain tight, as witnessed by over 100 basis points of high-yield spread tightening this year, and capital markets are wide open as evidenced by oversubscription of recent IPOs. Financial excesses also do not appear to be present as in previous downturns, such as excess leverage or a housing bubble. This cycle also has featured massive quantitative easing, which has distorted yields, especially when you consider that over $10 trillion in global assets have negative yields. Lastly, Canaccord Genuity points out that the median gain in the S&P 500 from the initial inversion to cycle peak is 21 percent, with recession occurring a median 19 months after the initial inversion.

The global economic data has been underwhelming, which has kept a lid on equity gains. The market appears to be seeking clarity on a few questions regarding the global economy. First, if and when does the global coordinated policy easing hit the real economy. Secondly, are we witnessing a temporary slowdown due to factors such as the government shutdown, weather, and protests in Europe. In recent years, the first quarter has been seasonally weak, only to have the economy rebound in subsequent quarters. Specifically, for the last three years first quarter growth has averaged 1.8% domestically, while the rest of the year has averaged 2.7%. Lastly, is the US consumer, which is approximately 70% of the economy, strong enough to prevent a recession and drive growth. For now, the US consumer remains in good shape, household debt service payments to disposable income are near historic lows, the savings rate is double pre-crisis levels, initial unemployment claims are near historic lows, and wages have ticked up recently. Further, certain leading indicators have begun to tick up recently, indicating that the economy may have stabilized.

The market appears to be consolidating within a range until we get some of these questions answered. Below the index level, lower rates, lower expected growth, and the flattening yield-curve are driving the action. In particular, lower rates have made high-dividend sectors such as REITs and utilities more attractive. Secular growth sectors such as technology are also more attractive in a lower growth environment. At the opposite end, a flatter yield curve has hurt financials, and lower global growth has hurt industrials and materials in recent trading. From an asset allocation perspective, if rates remain low, and it is confirmed that the global economy will continue to grow with stable inflation, do investors revert back to – TINA – there is no alternative, especially when you consider that equity earnings yield more than double the 10-year.

Looking forward, investors will focus on first quarter earnings, economic data, and progress on trade.

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Ketu Desai is the Principal of i-squared Wealth Management Inc. ( www.isquaredwealth.com ), an investment management firm based in New Jersey. ketu@isquaredwealth.com