CONSIDERATIONS, AUGUST 2019
The economy.
Peter Lynch, legendary Fidelity fund manager is known to have said, "If you spend more than 13 minutes analyzing economic and market forecasts, you've wasted 10 minutes."
Well, I'm not Peter Lynch, so you'll have to bear with me for just a little more than 3 minutes. This brief, no-nonsense, drama-free treatment is meant to get you comfortably on with a worry-free financial life. It'll also shield you from the pernicious effects of what other people might be telling you and what you're hearing in your self-imposed echo chamber.
Here are the paragraph headings if you want to scroll down fast. In some paragraphs, there are clickable links. Just use those if you're interested in the background or want to take a deeper dive.
The normal yield curve.
The yield curve right now.
Why is this?
Well then, who sets all the other interest rates?
Is there something special about a flat or inverted yield curve?
Are we close to a recession now?
Will tariffs or trade issues cause a recession?
What will happen to real estate if there's a recession?
Bottom line, what should I do?
Press on.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
The normal yield curve.
One of the most frequently heard terms these days is yield curve. Good grief, what's that?! We actually wrote about it in our blog back in March. You don't have to go back and read it. This note is a re-cap and update.
Here's a normal yield curve. It shows the interest rate that lenders receive for loaning money for different lengths of time. Notice how interest rates go up from the lower left to the upper right. In a normal world, the longer you loan money, the more interest you earn, yes?
Lenders are ordinary folks like us as well as pension plans, insurance companies, mutual funds, and so on, all over the world. For example, you're a lender when you buy a CD.
The yield curve right now.
It's pretty flat. Everything is squeezed in between 1.5% and 2%. No one is earning more for lending longer.
Why is this?
Some people might want you to believe that the Federal Reserve, aka "the Fed," "controls" interest rates. That's only partially true. The only thing the Fed does is set the Fed Funds Rate. That's the rate they charge banks and other financial institutions for overnight loans to clear the previous day's financial transactions. On the yield curve, the Fed Funds Rate is just one point at the far left or in the lower left corner.
Well then, who sets all the other interest rates?
The bond market!
Like stock prices are set in the stock market between buyers and sellers of stocks, bond prices are set in the bond market between buyers and sellers of bonds. Keep in mind that when bond demand is high, interest rates fall. When bond demand is not so strong, interest rates rise. Interest rates have been in a general downtrend since the early 1980's.
Is there something special about a flat or inverted yield curve?
As we pointed out last Spring, a flat or inverted yield curve has often presaged a recession. But the yield curve by itself is neither a cause nor a tripwire for a recession. It's just a picture of the bond market's assessment of future economic conditions. The actual causes, timing, and severity of any slowdown or recession are highly variable. So, there's no point in trying to game it.
Are we close to a recession now?
This 50-year graphic from the ECRI (Economic Cycle Research Institute) suggests that we're near the edge of slipping into a recession. But as you can see (1988, 2010, 2012, 2015), it's not 100% reliable. Nothing in markets is perfectly reliable. Furthermore, none of this says anything about the depth or duration of a recession, if it does happen. But I'm sure that Tweeter-in-Chief will keep us informed.
Will tariffs or trade issues cause a recession?
Global economies and financial markets are complex, chaotic, adaptive systems. What happened in a prior similar situation may not happen again. Yet, we ignore history at our peril.
Tariffs, trade issues, and executive orders have been a feature of the US economy since the beginning. George Washington issued the first tariff. Presidents Clinton, Bush, and Obama declared 42 national emergencies. Trump has signed four, so far.
We press on, regardless.
The lesson is that we've been here before. History may not repeat, but it rhymes. It's not different this time. There's always something to worry about. Trade is an ongoing, troubling, yet manageable challenge. Stay the course.
What will happen to real estate if there's a recession?
As we've all been taught, real estate is about location x 3. It's also about affordability.
According to Zillow, in the past year, median property values are -9% in the San Jose area, -13% in Palo Alto, -7% in San Mateo, flat in San Francisco, and -1% in Walnut Creek and Santa Rosa. Wow. If stocks had that kind of widespread downturn, we'd certainly be hearing about it.
These modest declines have nothing to do with location or recession and everything to do with affordability. Employment and incomes must keep growing to support rising real estate values. In some places, they are not. A recession will be a headwind for real estate. But that will also make it a buyers market, and with low mortgage rates to boot.
Bottom line, what should I do?
There are three things you can do-- three things over which you have absolute control:
1. Ignore the Tweeter-in-Chief's tweets. He's totally talking his re-election book. And by extension of that, avoid letting your political preferences-- whatever they are-- drive your investment strategy. That dog don't hunt; those dots don't connect. Remember when Trump was elected and "everyone" thought the market would tank?
Those "everyones" missed a 100% advance.
2. Advisors and investment firms always talk about knowing your risk tolerance. We take a different view on that. What you need to know is your volatility tolerance. How much tolerance do you have for watching your portfolio's value decline? Think in dollars, not percentages. A 25% decline (not that unusual) would trim $250,000 from your $1,000,000 portfolio. Would you be OK with that? Maybe this deserves a conversation. Call us. That's what we're here for.
2.1 Sidebar: People with large holdings of their company stock curiously seem to believe that their company's stock would not suffer in a market downturn because their company is just so good.
Don't be one of those people. Jobs and even whole companies can evaporate in a recession. I know; not yours, your neighbor's. Single issue risk can be devastating.
3. Find the places in your portfolio where bonds and other fixed income assets are sitting. That's what you'll want to use if stocks go into a funk. Have 3-5 years worth of likely withdrawals in sight. That way, you won't have to sell stocks low when they're becoming the thing you should be buying!
Any other questions? Contact a Jim.
In the Dallas-Ft Worth Metroplex jim.cosgrove@verizon.net 972-489-0262
In the San Francisco Bay Area jimcos42@gmail.com 408-674-6315
