Risk on or risk off?
The coronavirus appears to have inspired two distinct schools of thought among investors. Some investors currently favor opportunities that are considered lower risk, like Treasury bonds and gold, because they’re concerned about the potential impact of the coronavirus on the global economy. Others are piling into higher risk assets, like stocks, that could benefit if central banks (like the United States Federal Reserve) take steps to stimulate economic growth, reported Randall Forsyth of Barron’s.
Currently, the Federal Reserve (Fed) is holding interest rates steady. The minutes of the January Federal Open Market Committee meeting indicated the Fed, “…generally saw the distribution of risks to the outlook for economic activity as somewhat more favorable than at the previous meeting,” reported Lindsay Dunsmuir of Reuters.
Last week, Fed Chair Jerome Powell said it was too soon to know whether the economic effects of the coronavirus on the U.S. economy would warrant a change in monetary policy.
During periods of uncertainty, like this one, the benefits of holding well-allocated, well-diversified portfolios become clear:
Choosing a well-allocated and diversified portfolio that aligns with your goals, objectives, and risk tolerance can provide peace-of-mind when markets are volatile.
Last week, major U.S. stock indices moved lower. Al Root of Barron’s reported, “The Dow Jones Industrial Average dropped 1.4 percent this past week, snapping two weeks of solid gains…The S&P 500 index dropped 1.2 percent for the week…The Nasdaq Composite dropped 1.6 percent on the week…”
The CBOE Volatility Index (VIX), known as Wall Street’s fear gauge, moved higher.
Many stock markets around the world moved higher last week.
Investors’ optimism in the face of economic headwinds has confounded some in the financial services industry. Laurence Fletcher and Jennifer Ablan of Financial Times cited several money managers who believe investors have become complacent. One theory is investors’ buy-the-dip mentality has become so firmly ingrained that any price drop is seen as a buying opportunity, regardless of share price valuation.
Another theory is investors remain confident in the face of declining economic growth expectations because they expect central bankers to save the day:
“Key stock markets are hovering close to record highs even while the death count from the China-centered virus rises and travel in, out, and around the country remains heavily restricted, hurting the outlook for domestic and international companies. Regardless, stumbles in stocks are quickly reversed. To some traders, this is proof that investors believe major central banks will pump more stimulus into the financial system.”
Ben Levisohn of Barron’s doesn’t think investors in U.S. stocks are complacent. He wrote:
“Yes, [investors have] decided to stay invested in U.S. stocks, but compare it with the other options. Emerging market stocks near the epicenter of the outbreak? Treasury notes with yields of just 1.59 percent? Cash? But, they haven’t sat idly by, either. They’ve dumped the stocks most exposed to coronavirus and to a slowing economy – things like energy, cruise lines, airlines, steel.”
Treasury bond markets are telling a less optimistic story than stock markets. The U.S. treasury bond yield curve has flattened in recent weeks. On Friday, 3-month treasuries were yielding 1.58 percent while 10-year treasuries yielded 1.59 percent. When there is little difference between yields for short- and long-term maturities, the yield curve is considered to be flat.
Historically, the slope of the yield curve – a line that shows yields for Treasuries of different maturities – is believed to provide insight to what may be ahead for economic growth. Normal yield curves may indicate expansion ahead, while inverted yield curves suggest recession may be looming. Flat yield curves suggest a transition is underway.
Guidance Wealth will be closed Monday, February 17th to observe
George Washington’s Birthday
(aka Presidents Day)
Last week, major U.S. indices posted strong gains. That’s welcome news, but the drivers behind share price appreciation appear to have little to do with company fundamentals.
Fourth quarter earnings season is underway. During earnings season, companies let investors know how profitable they were during the previous quarter. With 45 percent of companies in the Standard & Poor’s 500 (S&P 500) Index reporting, earnings are slightly down. If the trend continues, this will be the fourth consecutive quarter of year-over-year earnings declines, according to FactSet.
Falling company profits, in tandem with rising share prices, have made U.S. stocks relatively expensive. The price-to-earnings ratio of the S&P 500 Index was 25.04 on Friday. That’s significantly higher than its long-term average of 15.78.
Expectations for economic growth may have been behind last week’s gains. Axios reported, “U.S. economic data had been strengthening ahead of the [coronavirus] outbreak – last month the all-important services sector notched its best reading since September, a private payrolls survey showed the highest job growth in five years, and consumer confidence held at historically high levels.”
The Economist Intelligence Unit (EIU) estimates U.S. economic growth will be 1.7 percent in 2020, although the coronavirus could create issues that slow growth.
Economic growth also could be inhibited by the national debt. The Federal Reserve Bank of St. Louis showed U.S. debt at about 105 percent of gross domestic product (GDP) at the end of the third quarter of 2019 (GDP is the value of all goods and services produced by the United States). According to the Council on Foreign Relations, high levels of debt can slow economic growth and divert investment from infrastructure, education, and research.
Ben Levisohn of Barron’s suggested last week’s gains might have been the result of limited supply and high demand for U.S. stocks, “…because the world’s problems might actually make U.S. markets more attractive.” Stock market gains may also owe something to supportive central bank policies.
During the next few weeks, stay calm and expect some volatility.
Prepare yourself. There is a good chance markets will be volatile in the coming weeks.
Precautions designed to slow the spread of the coronavirus may also slow Chinese economic growth and, by extension, global economic growth.
On Thursday, the World Health Organization declared the coronavirus to be an international health emergency. The U.S. State Department issued a travel advisory for China, and major U.S. airlines suspended flights to the nation, reported Forbes.
In six Chinese provinces, factories and businesses are shuttered until at least February 10. The closures have created issues for global supply chains, and Financial Times reported, “Companies from luxury retailers to airlines and banks are reeling as the disease accelerates.”
Events sparked a bond rally as investors shifted assets into safe haven investments. The Economist wrote that previous viruses have not had lasting effects on economic growth. “Other recent epidemics have reinforced the impression that economists should not be overly worried, so long as good doctors are on the job. Neither avian flu in 2006 nor swine flu in 2009 dimmed the global outlook. Yet even flint-hearted investors are wondering whether the new epidemic might be worse. Stocks in Hong Kong have fallen by nearly 10 percent as reported infections have steadily increased. Tremors have also rippled through global markets.”
China’s government is prepared to step into the breach. On Saturday, Reuters reported, “Chinese authorities have pledged to use various monetary policy tools to ensure liquidity remains reasonably ample and to support firms affected by the virus epidemic…” The Chinese central bank is expected to begin offering support on February 3 before the Chinese stock market reopens for the first time since January 23.
The European Union may also be in need of economic stimulus. Financial Times reported the Eurozone economy came to a virtual standstill (up 0.1 percent) in the fourth quarter and grew just 1.2 percent during 2019. Economies in France and Italy, the second and third largest in the region, both contracted during the fourth quarter.
Major U.S. stock indices moved lower last week.
Markets hunkered down last week.
News of the coronavirus outbreak in Wuhan, China unsettled investors around the world. The respiratory infection is related to severe acute respiratory syndrome (SARS) and Middle East respiratory syndrome (MERS), reported WebMD.
Previous virus outbreaks have affected global economic growth. Research into pandemic preparedness suggests extreme events can reduce global annual income by 0.6 percent per year (including mortality and income loss). Lower income often is equated with slower economic growth.
Viruses can also affect companies and share values. However, not every investment will move in the same direction at the same time, and not every country or industry will be affected in the same way. Barron’s reported:
“SARS infected more than 8,000 people in 2003, killing more than 770. The outbreak occurred between November 2002 and July 2003. Stocks of U.S. airlines – a proxy for travel-related shares – dropped more than 30 percent from pre-SARS highs during that outbreak, about twice the decline of the broader S&P 500 index. All stocks, it appears, were impacted by the outbreak. It took about three months for shares to bottom and another three months to achieve previous highs.”
China responded to the outbreak by imposing a transportation lockdown, and that could affect China’s economic growth. S&P Global explained:
“The coronavirus is hitting China during Lunar New Year, a period when households tend to spend more on travel, entertainment, and gifts. Even if the virus is contained fairly quickly, the initial stages of high uncertainty are likely to affect spending.”
In addition, the city of Wuhan, where the outbreak began, is a major transportation hub and a center for auto production. It is China’s sixth largest city, home to 11 million people, and responsible for 1.6 percent of the country’s economic growth.
Major stock indices in the United States moved lower last week.
The new trade deals are here!
The United States and China signed a preliminary trade deal last week. The next day, the United States-Mexico-Canada Agreement was approved by the Senate.
The phase-one deal between the United States and China has been analyzed, applauded, disparaged, and questioned. Here is a sampling of what’s being said:
“The eight-part deal includes protections for trade secrets and intellectual property, mechanisms for enforceability, and commitments by Beijing to increase purchases of U.S. goods and services by $200 billion over the next two years. It also broadens U.S. companies’ access to China’s markets…”
“While the deal isn’t insignificant – China has promised $200 billion in purchases…The sweeping U.S. goals to change the way China’s economy functions, from shrinking state-funded industries to strengthening intellectual property laws, are either absent from the deal or described in vague terms.”
-- Foreign Policy
“A truly grand pact between the two countries is some way off – and indeed, may never arrive. But this modest trade agreement shows how much the status quo has changed. Tariffs on hundreds of billions of dollars…of imports into both countries remain in place, with an ever-present threat of more. This is not trade peace, but rather a trade truce – and a tense one at that.”
-- The Economist
“Moreover, some countries are worried that $200bn of Chinese purchases of US goods that are part of the agreement will enshrine ‘managed trade’ between the world’s two largest economies, possibly flouting market forces, discriminating against their companies and violating WTO commitments.”
-- Financial Times
“One aspect that most have not addressed is that this is only a two-year agreement. What happens at the end of the two years is not defined…China has pledged to purchase $36.5 billion in ag products in 2020 and $43.5 billion in 2021. But the issues are no one believes either side will keep up their end of the bargain.”
Despite a diversity of opinion about the deal, investors were happy. The Dow Jones Industrial Average surpassed 29,000 for the first time and was up 2.8 percent for the year through last Friday, reported Barron’s.
The Guidance Wealth office will be closed
Monday, January 20th, in observance of Martin Luther King Jr. Day.
It was a nerve-wracking week.
Iran fired 22 ballistic missiles at the Ain Al Asad air base near western Iraq and a second base in northern Iraq following last week’s U.S. drone strike that killed a top Iranian military commander. Newsweek reported the bases suffered minimal damage and there were no casualties from the attack. However, Iran mistakenly downed a commercial airliner, killing all on board, reported CBS News.
U.S. stock prices faltered after the initial attack, but recovered quickly when both sides, “…step[ped] back from further violent escalation…,” reported Barron’s.
U.S. Treasury bond yields dropped sharply last week before rebounding. Financial Times reported the possibility of war caused global investors to seek out investments perceived to be safe havens. Record amounts of cash moved into bond investments, particularly U.S. Treasuries, during the week ended last Wednesday.
Australia was ravaged by wildfires. Citing the Insurance Council of Australia, NPR reported, “The wildfires have killed more than two dozen people, more than a billion animals. They've destroyed more than 1,800 houses, an untold number of commercial buildings and thousands of acres of prime farmland…” At the end of last week, 130 fires were burning and 50 were uncontained, according to the BBC. The damage could mark the end Australia’s nearly 30-year economic expansion.
Puerto Rico was shaken by a 5.9 magnitude earthquake. The quake followed a magnitude 6.4 quake that hit the same region four days earlier, reported the Associated Press. Since December 28, the region has been hit by, “…more than 1,280 earthquakes, of which more than 100 were felt and more than 70 were of magnitude 3.5 or greater.”
On Friday, a tepid U.S. employment report cooled U.S. stock returns. However, Barron’s reported all three major U.S. indices closed, “within a half-percentage point of their highest-ever closes.”
2019 was a remarkable year for investors with many asset classes delivering positive performance. Both the Standard & Poor’s 500 Index, a gauge of U.S. stock market performance, and the Dow Jones Global (ex U.S.) Index delivered double-digit increases (see the below table). Bonds and gold rallied, too, delivering positive returns for the year.
Possibly the most important factor contributing to asset performance in 2019 was an ‘about face’ by the United States Federal Reserve. Axios reported:
“The Fed’s 180-degree turn was the story of 2019, asset managers and market analysts say…Chairman Jerome Powell and the U.S. central bank went from raising interest rates for a fourth time at the close of 2018 and giving market watchers the explicit expectation this would continue in 2019, to doing the opposite. The Fed cut rates thrice and even began re-padding its balance sheet in the last quarter of the year, bringing it back above $4 trillion.”
The Fed’s policy decision gave investment markets a boost, however, it did little to quell investors’ worries about potential recession and the impact of the U.S.-China trade war, reported The Wall Street Journal. As a result, investors moved money from U.S. stock markets into bonds and other investments they perceived to be safer throughout the year.
During the fourth quarter of 2019, U.S. markets delivered positive returns despite uncertainty about the strength of the U.S. economy created by inconsistent economic data. For example, the last jobs report of the year indicated unemployment remained near a 50-year low. Yet, in 2019, workers experienced the highest number of layoffs in a decade.
Many layoffs during the year were the result of corporate bankruptcies, especially in the retail sector. Investors who took time to evaluate the juxtaposition of unemployment levels and layoffs may have recognized disruptions in the retail sector has potential to create opportunities for investors.
A closely watched indicator during 2019 was manufacturing. In December, Fox News reported, “The ISM Manufacturing Index fell for the fifth month in a row to 47.2 in December, down from November's reading of 48.1. That's the weakest reading since June 2009, when it hit 46.3, and well below the 49 reading that economists surveyed by Reuters expected.”
One of the reasons for weakness in manufacturing is the U.S.-China trade war. Late in the fourth quarter, concerns about trade subsided after the announcement of a phase one trade deal. The agreement is scheduled to be signed on January 15, 2020.
Continued progress in resolving the trade war could help boost economic growth in the United States. At the end of 2019, United States gross domestic product, the value of all goods and services produced in the country, was expected to remain slow and steady during 2020. However, forecasters at the Federal Reserve Bank of Philadelphia expected the economies of nine states to contract during the first six months of the new year.
From a geopolitical perspective, the 2020s are beginning just like the last decade did, with all eyes on Iran.
In 2009 and 2010, the Iranian Green Revolution captured the world’s attention as social media provided insight to post-election turbulence and unrest in Iran. Last week, the first of the new decade, all eyes were again on the Middle East as tensions between the United States and Iran flared after the death of a top Iranian military leader targeted by the United States.
After rallying on the first day of the new decade, some major U.S. stock markets declined on news of heightened tensions in the Middle East and concerns about the potential consequences, such as the disruption of oil supplies.
The Guidance Wealth office will be closed at 12:30pm Tuesday, December 31st and all day Wednesday, January 1st for the New Year’s Holiday.
Our office will be open 9am – 4pm on Thursday and Friday, January 2nd and January 3rd.
2019 will be a hard act to follow.
Investors may find themselves reluctant to ring out the old and ring in the new this week. During 2019, stock and bond markets delivered exceptional returns.
Ben Levisohn of Barron’s reported the Dow Jones Industrial Average was up 23 percent at the end of last week, the Standard & Poor’s (S&P) 500 Index had gained 29 percent, and the Nasdaq Composite was up 36 percent. The S&P 500 and Dow both closed at all-time highs.
Bond indices showed gains in the United States and around the world. The Bloomberg Barclays U.S. Aggregate Total Return Index was up 8.87 percent at the end of last week. Its global counterpart, the Bloomberg Barclays Global Aggregate Total Return Index, was up 6.63 percent for the same period.
After a year like 2019, when stock indices delivered exceptional returns, investors’ perceptions about their appetite for risk can change. Great market performance has a way of persuading people their tolerance for risk is higher than it has been in the past. The phenomenon has something to do with recency bias, which is a tendency to remember and weight recent events more heavily than past events.
In other words, during bull markets some people tend to forget about bear markets.
2019 was a wonderful year, but not every year will be like 2019. At the end of last week, the average annual return for the S&P 500 Index over the last 60 years, with dividends reinvested, was about 9.5 percent.
The fact that 2020 may not be like 2019 does not mean it’s time to sell. Successful financial plans and investment strategies should include well-diversified portfolios that are grounded in the investor’s life and financial goals. Every strategy and portfolio should be reviewed periodically and modified when goals have changed, a major life event has occurred, or the investor’s risk tolerance has changed.
If you would like to talk about your strategy and review your portfolio allocations, give us a call. We’d like to hear from you.
The Guidance Wealth office will be closed on Tuesday and Wednesday
December 24th and 25th for the Christmas Holiday.
Let’s hear it for 2019!
Major stock indices in the United States and overseas are poised to deliver double-digit gains for the year. Even with uncertainty about Britain’s exit from the European Union (EU), the FTSE 100 boasted a gain of more than 10 percent at the end of last week. That’s not bad for a year which included (in the United States) an inverted yield curve, an earnings recession, and a contentious trade war.
The strong stock market performance of 2019 owes a lot to central banks, and so does the performance of the bond market. Reuters reported,
“…the screeching change of direction by the world’s top central banks, led by the Federal Reserve, which cut U.S. interest rates for the first time since the financial crisis more than a decade earlier…fired bond markets up like a rocket. U.S. Treasuries, the world's benchmark government IOU, have made a whopping 9.4 percent after yields plunged as much as 120 basis points…German Bunds – Europe's safest asset – have had their best year in five years, making roughly 5.5% in euro terms as the European Central Bank has reversed course too.”
So, what lessons should we take from 2019?
Perhaps, we should try to come to terms with loss aversion. When you make an investment decision, it’s important to consider the impact of loss aversion on your thinking. The pain from a loss carries twice the impact of the pleasure from a gain. As a result, fear of loss may affect investment decision making.
2019 offered a great example. During a year of exceptional returns, investors pulled money out of stocks at a record pace because they were worried about recession and other issues. Axios reported,
“Data from the Investment Company Institute shows money has been pulled out of [stock investments] in every month this year except January. In total, more than $130 billion has been drawn from [stock investments] in 2019, making it already the largest year of outflows on record.”
When it comes to investing, uncertainty is normal. It is part of investing. Tolerating uncertainty may help investors earn attractive returns. As a result, our advice is to stay invested even when uncertainty makes you nervous, even when markets are falling.
If you have a diversified portfolio built to help you reach your goals, stay with it, unless you risk tolerance has changed. In 2019, pulling money out of stocks meant some investors missed out on some exceptional returns.