Assessment of current situation and how it relates to you
Sentiment about the markets and the economy is a funny thing. The investment and economic world is filled with numbers and data, but how do you calculate a feeling? There are surveys, investment flows and even indexes meant to try and measure those feelings. But are feelings accurate when it comes to quantifying the past and forecasting a future outcome? And if feelings about the markets and the economy are relevant, what happens when they change?
The measurement of a feeling is particularly interesting when it comes to assessing investments and their value. What’s X worth as compared to Y? Does it seem like a good price now and possibly a better price in the future? That’s how rationale begins to calculate figures to determine fundamental value. But when a feeling is involved, do quantifiable, things matter anymore? In normal, healthy, manipulated-free markets and economies, fundamental metrics like earnings and GDP make up the foundation for determining and assessing value. But for some time now, the markets and the economy are ignoring the basics.
Markets are disregarding statistics, historical context and assume, based on a pattern over the last few months or years, that things will continue as they have been. Markets also assume, that since the Federal Reserve has bought up most bonds during QE (Quantitative Easing) and dropped interest rates, causing a massive redirection of cash flow in a desperate search for return, that value doesn’t matter anymore. Well, history doesn’t repeat itself, but it sure does rhyme and value always matters. Consequently, when that feeling or sentiment does shift, it will have to come to grips with the reality of a weak recovery, that created a lack of quality jobs, and rising interest rates.
Growth
The US’s first quarter’s GDP (Gross Domestic Product), which essentially measures the health of the economy, or “stuff” produced and sold, was very, very weak. With an historic amount of stimulus from the Federal Reserve over the last 70 months, the GDP figure had been expected to be robust and growing. Actually, the first quarter of 2015 GDP growth was -0.7% annualized or more accurately -0.18% for the first three months of the year. To make yearly comparisons simpler, the -0.18% figure is multiplied by four to get -0.7%.
To put that number in perspective, for the last 33 years, up to the end of 2014, GDP averaged 2.7% per year. However, since the fourth quarter of 2007, GDP has only averaged 1% annually, making this the weakest recovery in history.
Historically speaking, in order to support a strong, substantial long-term bull market run, a healthy economy, shored up by productive participants making lots of stuff and eager consumers buying lots of stuff, needs to be present. If GDP is weak and weakening, then our economy is weakening, making it harder for the system to maintain prosperity. This ultimately affects not only investments in these company’s stocks, but the companies who employ investors.
US GDP source Bloomberg
Jobs
Unemployment is currently at 5.4%. But like all things, the devil is in the details. What kind of jobs are represented in that figure? Unfortunately for those looking for careers, part time workers are making up more and more of the country’s workforce. The 2 million job loss in the breadwinner sector (jobs paying an average of $50k per year) has been off-set by an equivalent gain in the larger part-time economy. 1
While these jobs are important to keep the consumer economy going, they are hardly secure enough to allow one to decide to buy a home, start a family and spend without discretion. Two thirds of GDP is based on consumer spending, which makes spending beyond the essentials especially difficult without the income security a full time job offers. The lack of breadwinner jobs and the abundance of part time jobs paints a grim picture of the quality of this recovery and an even more bleak outlook for those looking to start a career.
1 http://davidstockmanscontracorner.com/52247/
Rates
Does it matter that interest rates on US government bonds have begun rising? Yes. Why? Rising interest rates affect bond values. Rates go up, values go down. The increase in the interest rate of the bond will help offset some of that decline, but how much depends on the duration (measure of how long the bonds have to maturity). To counter the rise in rates, an allocation to shorter duration bonds, a heavier concentration in cash or an investment in a vehicle that can hedge against rising rates can prove effective.
Do rising rates affect investments in real estate stocks or mutual funds? Yes. In April, and now into May, rates have risen, causing a decline in the value of real estate investments and homebuilder’s stocks. Since homebuilders’ cost of borrowing money to buy and build real estate goes up, it ends up putting pressure on prices. Therefore, reducing investment exposure to real estate investments would help mitigate losses due to rising rates.
Similarly, most companies borrow money to run their businesses, resulting in higher expenses for them as well. Companies will have to take action to counter that increase in costs, which may include either raising prices or reducing wage costs, also known as layoffs. If they cannot accomplish enough cost cutting to offset rising rates, then they will make less profit, ultimately justifying a lower stock price.
In summary, markets and economies primarily supported by feelings, sentiment and central bank intervention will eventually have to wake up to the reality of the situation. Without the support of a healthy growing economy, strong quality employment, and moderately rising interest rates, historic stock and bond market levels cannot be justified. Considering the current situation, investors should be cautious during this transition in the markets. Investors need to consider adhering to a risk managed investment strategy due to the emerging shift in focus from sentiment to fundamentals, which may indicate the markets are moving into the final leg of this cycle, a corrective phase.
Author’s Note: Information, news and numbers about our country’s economic health are everywhere. Without a good filter and translator, it is difficult to understand why it matters to you. I stand as your filter, your translator and explainer of the financial jargon that is clogging our airwaves to help you make heads or tails out of its meaning to your situation. My goal is to simplify the meaning, provide perspective, and challenge the context of the information. – Steve DeCesare, CFP®
About Steve DeCesare, CFP®
Founder and President of DeCesare Retirement Specialists
Stephen DeCesare, CFP®, is founder and president of DeCesare Retirement Specialists, an independent financial and retirement planning firm based in Marlton, New Jersey. DeCesare is a leading retirement transition specialist who has spent the last decade of his career helping professionals retire with confidence.
His multi-disciplinary planning approach works to ensure that the investment, income, insurance, tax and estate strategies are in place to achieve his clients’ financial and lifestyle goals for retirement. DeCesare offers guidance to corporate employees regarding their 401(k)s, pensions and IRAs, including rollovers and investment decisions. He also assists professionals going through workplace transition, with the critical decisions and financial plan adjustments needed to help ensure a smooth progression of their financial life as they enter into their next job or retirement.
DeCesare is a CERTIFIED FINANCIAL PLANNER™ professional, Investment Advisor Representative of DeCesare Retirement Specialists a Registered Investment Advisor, a Registered Representative under Triad Advisors, and he is life and health insurance licensed in the states of New Jersey and Pennsylvania. DeCesare’s financial expertise has been featured in USA Today, Money magazine, and Bankrate.com. DeCesare is an approved five star rated advisor with Paladin Registry, a member of the Financial Planning Association (FPA) and FPA NexGen and a recipient of the 2012, 2013, and 2014 Five Star Wealth Manager Award.
For more information about this Update and Steve DeCesare, CFP® please call 856.235.3830 or email Steve@DecesareRetirement.com.