The Finance Gourmet

Personal Financial Advice from a former Certified Financial Planner

Market Falls, But… No Panic… yet?

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So, interesting phenomenon happening in the stock market these last few days with the S&P 500 dropping over 5% (around 1,400 points) and even dipping below its 200-day moving average. In the right circumstances, this might be the trigger of a full-on rout in the stock markets.

Here is what is missing though: panic.

Markets Down – Does Anyone Care?

I’ve been subtly (and not so subtly) hinting for about a year now that I think the Federal Reserve is too set in stone on its course to raise interest rates in the face of little to no inflationary pressure. To me, this recovery, as long as it is, doesn’t seem that strong. As such, one rate hike too many, could spell disaster.

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With this week’s market reacting poorly to rising interest rates in the bond markets, I was dusting off my “I Told You So,” posts. But, it looks like I’ll have to wait a bit longer.

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Despite the fairly big numbers in the Wall Street sell off as late, there isn’t much fear associated with it. When it comes to the economy, nothing matters more than how people FEEL about it. That’s why they try so hard to measure those feelings with thinks like sentiment indexes, and the like.

Unfortunately, measuring how one person feels is tricky, you can imagine how it is when you are trying to measure millions of investors and participants in the economy.

For my part, all I can do is measure what I see and hear around me. That’s a bit larger than it once was, thanks to social media, and websites like this one, but it still isn’t statistically valid. That being said, if you get a big enough chunk of the right people, your approximation can be just as good as the real thing.

My approximation right now has everyone looking at this current market downturn as a, “Oh, yeah. We knew that was coming sooner or later.” In other words, long-term investors, and others are shuffling their decks, but are not running for the exits. That means without another push down the hill, this MIGHT be all we see of this little downturn — a few days of market declines (albeit big ones), and then back to normal.

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If, and that is a very big IF, that’s how things go down, then turn 100% of your attention to housing. Rising rates mean rising mortgage rates, and if there is a way to pop this long-term economy, it’s to send everyone back to their bunker mentality regarding real estate.

Stocks Have Hard Day – Just Volatility, or the Recession Knocking?

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Stocks had a pretty big selloff today in response to a big drop in the bond markets.

For those of you keeping score (the baseball kind, not just the points scored), here is the way the game looks so far.

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  • US economy is still expanding, making it one of the longest economic expansions
  • The economy itself is cyclical. It ALWAYS goes up AND down. So, if it has been going up for a very long time, sooner or later, there will need to be a correction, or recession. How hard the recession ends up being is a function of how it hits. A “pop” leads to a hard (potentially shorter) recession. A “soft landing” means markets can regroup and reprice (usually with a lot of sideways movement) without shocking the system.
  • The Fed keeps raising interest rates because… well, because they want to be “hawks” and not “doves” and just for the barest of moments, the supposed “target” of 2% inflation was touched, so here comes the Fed.
  • The Fed not only keeps raising interest rates, it keeps saying it is going to raise interest rates more. One more hike this year, in December, and three next year. That’s a lot of increase.
  • The bond market is starting to notice. Why would you take on a 10-year Treasury now, when you know in a year, the rate on a 1-year Treasury might be just as high?
  • This is called a compressed yield curve. Usually, you get more reward (higher interest rate) in relation to more risk (longer holding period). These days, there hasn’t been much spread between short-term rates (the ones the Fed moves) and longer term rates like the 10-year interest rates.
  • Anyone who has ever played with a rubber ball knows that the more you squeeze it, the more it bounces back when you finally let go.
  • The yield curve has been getting squeezed more and more. The last squeeze was in September, the next one is coming in December. The bond market reacted with a boing.
  • Why Now?
    • This one is kind of fun. There was a change in tax law reporting that made big purchases before September 30 much more advantageous than purchases after.
    • Anyone who needed to buy a big chunk of 10-year Treasuries did it in September instead of October.
    • Once the big buyers moved out prices naturally fell in response (more supply, less demand).
    • Once they moved down, they triggered selling by other investors, which pushed prices lower, which triggered selling by other investors, which pushed prices lower…
  • Now, 10-year Treasury rates are higher. Higher enough that it is going to start affect mortgage interest rates, and…
  • The housing market was just starting to show signs of slowing down. Higher interest rates would turn a slight slowdown into a full bloom slowdown.

crystal ball stock market economy

Crystal Ball Time

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What happens next?

As always, predicting the future is tough. But, here goes.

In one scenario, U.S. companies are still doing just fine. Earnings are still strong. Workers still have plenty of jobs, even if pay isn’t really increasing. It’s frankly probably a good thing if housing prices aren’t rising so fast. – In this case, there will be some volatility while the markets reestablish equilibrium, but in the end, the expansion continues.

In the other scenario, U.S. companies are doing well, but not THAT well. With no more momentum toward higher stock prices, the markets stall. Yet another interest rate hike is coming and everyone reacts. Higher interest rates drive the housing market lower. Less housing, means less housing starts, which means less housing jobs. People also don’t refinance since higher rates makes it less attractive. They don’t use the equity in their house for remodels, vacations, whatever. Fewer jobs makes people less confident and they cut back on spending. That creates a hard shopping season, which tips over the retailers in the markets. Computer programs kick in and do the rest of the damage. The recession begins, once again triggered by a Federal Reserve that HAD TO raise interest rates not because the data compelled them to, but because they were “hawks”.

Which scenario is it this time?

I don’t really know, but what I do know is that Scenario 2 is coming. I just don’t know if it is now, or later.

Interest Rates Rising Into the End of the Year

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The Federal Reserve did not increase interest rates at its August 1st meeting. That was widely expected after the increase from the pervious meeting. Traditionally, the Fed tries not to raise rates in back to back meetings unless it feels like the economy is getting away from them. It allows the markets, and just as importantly, the economic data The Fed relies on to adjust to the previous hike before implementing another one.

Rate Hike In September

The Federal Reserve Bank did try and telegraph that it is currently looking at another rate hike for September. While the Fed did not raise rates, it did repeatedly say how “strong” the economy was, and how strong all the economic data was.

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And, for the first time in a long while, inflation is actually running near the Fed’s so-called target rate of 2%. While the Fed’s actions seem much more like 2 percent is a ceiling, rather than a target, recent data does suggest that inflation is running solidly near the two percent mark, so action is likely warranted.

Will Higher Rates Trigger the Recession?

Here is where things get tricky.

economy defenses

While the Federal Reserve cannot let inflation run wild, the fact is that the current expansion of the U.S. economy is coming up on “longest ever economic expansion” territory. Add to that the uncertainty of the mid-term elections in the United States, an wobbling international economy, and the thundering bull-style tariff implementations of the Trump administration, and there are a lot of winds buffeting the economy. Any one of them could knock it off course, and trigger the next recession.

Fate has a heck of sense of irony some times.

The Great Recession was arguably caused by the Federal Reserve raising rates to cool off an overheating economy powered by unrealistic real estate market reaction.

The big internet bubble pop recession was also triggered by a Fed raising rates into the “irrational exuberance” of a stock market where valuations no longer made any sense.

And, here we are, an economic expansion on its last legs with plenty of uncertainty all around and here comes the Fed with — you guessed it — a series of interest rate hikes.

Will history repeat itself?

Unfortunately, the answer is almost uncertainly yes. This next rate hike, and maybe even the next may be tolerated and absorbed into the enormity of the U.S. economy, but the Fed can’t seem to contemplate what it might be doing OTHER than fighting inflation. Other Feds preached the value of the soft-landing, but this Fed hasn’t even THOUGHT about the fact that its own actions might causes circumstances that require a soft landing.

As always, I am not a fan of market timing for long-term investors. I do encourage you to rebalance your portfolio if it has been longer than a year, and take a real hard look at your risk tolerance. In the next year or so, it is VERY likely that you will be looking at your portfolios’ expected LOSS rather than your portfolio’s expected gain.

The one thing we have going for us this time around is that no matter how much politicians have tried to ruin the progress made in securing better capitalization for banks during the Great Recession, the fact remains that most banks are in a much stronger position to help withstand the winds of a market crash this time around. That doesn’t mean it will be fun, it just won’t be a complete and total threat to our entire economic system.

In the next month I’ll be building up a series of articles on how to prepare for the imminent recession. Bailing out of the market for long-term investors is not one of the steps, but there are things you can do now. For starters, make sure the job you have is the one you want for the next few years. Finding a new job is always harder during a recession. If you’ve been thinking about moving the time is now. Just be sure that wherever you land will both be able to weather the storm, and will be willing to keep you during it. Now isn’t the time for risky, companies that might not make it.

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If you are thinking about buying a house, make sure you are not reaching for the payment. Your next raise is likely the last for a few years. Same thing with car payments, or any other payments for that matter.

If you don’t have an emergency fund, bump the priority for saving one up to the top. You just might need it soon.

Don’t panic, but be smart. Make conservative financial decisions for the next 12 months.

November Looking Funky for Stock Market

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These last few weeks have dumped piles of external events onto the stock markets. As usual, the market overreacts to many of these and under-reacts to others. For long-term investors, this is just another reason to have a well diversified portfolio that you rebalance regularly.

Market Data and Other Stuff

Just because you aren’t going to panic sell (right?) or run out and buy fearing you are missing the start of another rally (right?), doesn’t mean that we can’t take a look at what is going on in the economy, markets, and politics that might affect our investments over the coming months.

First up? The Fed!

President Trump has announced his pick for the next Federal Reserve Chairman, and it’s a known quantity. Jerome Powell is already on the Federal Reserve Board and holds views that are considered mostly similar to those of current Fed Chair Janet Yellen. In fact, many analysts suggest that there is no real purpose in replacing Yellen with Powell other than for the President to put his stamp on the board.

stock market end of year economy

It all adds up to more of the same. A Federal Reserve focused on “normalizing” interest rates (raising them) despite the economy coming in well below anything approaching the Fed’s so-called 2% inflation target. Look for one more rate increase in 2017, or a January 2018 increase unless something goes kablooey between now and then.

Next? The Economy!

Jobless claims were up, but everyone is attributing that to the effect of the hurricanes. This analysis is borne out by the fact that continuing unemployment claims (people who were already on unemployment last period continuing to be on it this period) falling. Add it up and the job market is doing fine. Not on fire, but not shedding jobs either.

The Big Bad Wolf in our story, however is the Producer Price Index. Expected to come in with a 0.1% gain, the report showed the index rose 0.4% in October. Typically, big surprises like this get revised back the following month, but even a 0.3% increase is a pretty big deal. This finally is actual evidence that inflation may be building in the economy.

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So, the rub is that the latest increase the Fed made to interest rates is still working its way through the economy. The question is, would that increase be enough to slow inflation, or do we need another? The answer, whether it is right or wrong, according to the Fed is that we need another increase. With this report, there is no doubt we’ll get one, unless there is a kablooey.

How about Earnings?

Stocks have performed almost exactly like you would expect them too. Companies that have been troubled lately reported earnings that were troubling. Companies that people expected to be doing well, had good earnings. Maybe the only surprise was Wal-mart, who did even better than expected, after doing better than expected already earlier this year.

For doomsayers who worried about the company’s future in the wake of its decision to boost up the minimum wage it pays employees, it looks like Wal-mart has figured out how to make money anyway.

Finally… Politics!

Tax cuts are coming! Tax cuts are coming! Or maybe not. You never know with Washington. Wall Street loves a tax cut, and the Fed loves calling tax cuts inflationary, but the current tax cut bill in Washington doesn’t really cut taxes so much as move them around a bit.

It takes back certain itemized deductions, in order to give out a bigger standard deduction. If anything, this tax bill might make your taxes a tiny bit simpler if you are one of those taxpayers who it near the break-even point on itemizing versus taking the standard deduction.

Now What?

It’s end of year time! That means that all of this is about to become meaningless background noise. When it comes to the U.S. economy, nothing is more important than holiday shopping season. If analysts get worried about holiday spending, the markets are heading down. If they like what they see, they’ll get a boost.

Often no one can tell if things are good or bad until the companies tell us next year. That’s why you often see a Santa Claus rally in December when in the face of limited data, spending seems good enough.

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Watch out for a bumpy January though. A Fed rate hike, plus actual holiday data, plus a new year, might just set us up for a solid correction in early 2018. Whether it sticks around, or is a temporary blip will depend almost entirely on if the job market keeps on going.

Kablooey!

You never know what will happen that has nothing to do with balance sheets, interest rates and economic data that can send everything sideways.

Kablooey is when something blows up (usually metaphorically, but not always) that causes a shock to the markets. There seems to be a lot of potential kablooey out there ranging from increasingly bizarre politics only loosely tethered to reality, to North Korea, to Russia, to the Russia investigation, to environmental issues, to terrorism. If something goes kablooey all this analysis goes out the window and we start over.

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