The Good, The Bad, and The Money Volume 4
Fun Fact Number One: On November 14th, 1889 New York World reporter Nellie Bly set sail from New York to put Jules Verne’s 1873 novel Around the World in Eighty Days to the test. Making use of transport ranging from camels to Chinese junks, she completed the trip in a record 72 days, six hours, 11 minutes, and 14 seconds.
After a turbulent October, the stock market moved into positive territory to some degree. November typically is the fourth-quarter month where stock prices and performance go up. This is due in part to an investment strategy called “window dressing,” where mutual fund portfolio managers at quarter- end or near year-end look to improve the fund’s performance before presenting the results to shareholders. Essentially, mutual fund managers sell underperforming stocks in the portfolio and in turn purchase stocks that are on the rise. No one really wants to hold on to stocks that are underperforming. Therefore, if a company by the third quarter isn’t turning around, fund managers move those stocks out of the portfolio.
In this month’s edition of The Good, The Bad, The Money, we will continue to explore and report on several topics, including (but are not limited to) consumer sentiment, wages, market performance, inflation, and a few others.
A few good things to point out throughout the month of November are (in no particular order): consumer sentiment data, wages, inflation, and market performance.
As we review consumer sentiment, this important measure tells us how investors are feeling about the market. As noted before throughout the year, investor concern with and expectations for market performance change. After a somewhat turbulent October, it was expected that consumer sentiment would be adversely affected. This type of uncertainty is typically due to market conditions and performance over the month of October, which historically has been a challenging month for investors.
According to the American Association of Individual Investors (AAII), investors typically feel one of three ways about the market: either they are bullish, bearish, or neutral.
In their survey ending the week of November 14th, the AAII found bullish sentiment and expectations that stock prices will rebound from their October performance. The average bullish sentiment increased to 35.1%, which is up 4.5% from October’s 30.6% figure. This increase may come as a surprise to some investors, being that October is typically a negative month. With that said, 36% of surveyors responded as being bearish on the market, which translates to a shifting viewpoint of the economy and the market. This figure is also surprising, as it translate into a 6% increase in bearish views compared to the historical average.
The University of Michigan’s monthly report shows some interesting results. Keep in mind that consumer sentiment is a statistical measurement and economic indicator of the overall health of the economy as determined by consumer opinion. The University of Michigan Consumer Sentiment Index (CSI) is a consumer confidence index published monthly by the University of Michigan. According to the CSI, consumer sentiment surprisingly remained unchanged during the the first half of November. The index hit 98.3 although economists forecasted the index to be at 98. However, this is slightly lower than October’s forecast of 98.6. Essentially, this means consumers have remained cautiously optimistic about the U.S. economy and its continued growth potential. CSI’s chief economist, Richard Curtin, stated that consumer sentiment stability at high levels acts to mask some important underlying shifts. Income expectations have improved and consumers anticipate continued robust growth in employment, but consumers also anticipate rising inflation and higher interest rates.
With that said, let’s take a quick look at wage growth and inflation.
Approximately 250,000 jobs were created in October. The areas of employment that improved included health care, manufacturing, construction, transportation and warehousing. With that said, the unemployment rate has held steady at just under 3.7%. This continues to prove that the economy is still strong in terms of putting people to work. With a low unemployment rate, more people are working and contributing to the American economy. According to the United States Department of Labor, wages, salaries, and employee costs for benefits have risen. While the unemployment rate of is low, wages have moved in a positive direction, but not at the same rate as inflation. With U.S. currently at 2.3%, in order for consumers to take advantage of increased wages, the inflation rate would have to decrease. This doesn’t seem likely in the foreseeable future.
Fun fact Number Two: The last seven Novembers (excluding November 2018) have been positive; this streak would be tied for the longest stretch in 50 years. (1977-1983).
Market Performance: As mentioned before, the stock market has had an incredible bullish run over the last 10 years. Investors have seen tremendous portfolio growth and they have thrived in this investor friendly environment. But all good things must come to an end. After a turbulent October, November would typically seem to be poised for a great market run. Historically, November has been a month where the market corrects itself and rebounds from its October lows. However, things seemed to change this November. The overall markets seemed to continue its inconsistent performance with the Dow and the S&P having consistent sessions of near correction performance. This signals a concern that equities will likely have a deeper and more pertinent selloff than most investors anticipate. Consider these statistics according to USAToday:
• In the past 20 years, the Dow has posted average gains of 1.9% in November, third best of all months, says Bespoke Investment Group.
• In the current bull run that began in March 2009, the broad S&P 500 stock index gained 1.75% in November vs. an average gain of 1.2% in Novembers since 1983, Bespoke data shows.
• In years like 2017, when stocks have been up 10%+ through October, the S&P 500 averaged a November gain of 2.7%. By the month of December, it finished up 87% of the time.
Now some economists would argue that the 2018 November elections had something to do with the performance of the markets. It’s plausible that the current administration will blame the Fed’s hawkish orientation on monetary policy, as well as the Democrats, who just took over the house. Higher interest rates, growing deficits, and trade disputes have all contributed to the recent market selloff in the market.. In fact, the Fed plans to continue raising rates to about 2.5% in December 2018, and up to 3.5% through 2020. The rising rates will certainly prove to be effective in slowing down the economy; however, the financial markets may not take kindly to it. As rates rise, the cost of borrowing will also increase, which means banks will lend less and investors may purchase less via terms of debt. In fact, the recent rate hike is expected to crush the lending market for those who are investing in variable rate consumer lending products, such as car loans, credit cards, home equity lines of credit, and adjustable rate mortgages.
Now one positive outcome is that rising interest rates typically prove beneficial for investors who invest in bank savings vehicles such as money markets and CDs. We are now seeing banks increase their interest rates on those products to encourage consumer interest. After eight Federal Reserve interest rate hikes, we are starting to see CD rates in the 2.5% range or higher. An interesting aspect about this is that big banks are not competing for these deposit dollars, as they are already cash heavy in that space. However, this leaves room for your local, less commercial and credit union banks to win back some of the dollars lost to the big banks.
Debt: As I stated in volume 3 of The Good, The Bad, and The Money, the national debt has eclipsed $21 trillion dollars, a 6.9% increase from the previous year. This deficit is now being fueled by the U.S.-China trade war. Investors fear that this trade war will have a lasting effect on the U.S.’ ability to maintain have a healthy import/export relationship with key companies operating in other countries. MarketWatch conducted a survey in November to gauge consumer sentiment around the holiday season and whether the trade war with China would effective their spending decisions. Below are the results:
44% said they would compare prices of products more closely
22% said they would avoid buying products made in China
19% said they would avoid buying products that are impacted by tariffs
16% said they would buy fewer gifts than in previous years
This is a clear indication there may be some economic impact on Chinese products sold in the United States. This trade war will not only affect Chinese products, but also domestically-produced goods. Some farmers are concerned they will out-produce commodities they would normally sell to China. If this holds true, these farmers may potentially lose some of their commodities (such as soy beans) due to weather issues or poor storage facilities. Reuters recently reported that grain farmers across the United States are plowing their crops, leaving them to rot or piling them on the ground in hopes of a better trade situation next year. In addition to the trade war currently crippling the United States, the financial deficit continues to increase.
I think it’s worth restating this deficit from a chart perspective. As you can see from the chart below, the U.S. national debt is comprised of U.S. investors, the Fed, U.S. government, and foreign investors. The rising debt is a concern for global investors, especially in the United States, as U.S. investors hold more than $6.89 trillion in debt. The United States is about to hit a new debt milestone – According to JPMorgan, the federal government’s total debt owed to outsiders has exceed all U.S. household debt for mortgages, credit cards, cars, student loans, and other personal loans. The U.S. debt is now up to $127,000 per household. If things continue in this way in which they are, who knows what will become of the national debt.
Fun Fact Three: November is the 11th and penultimate month of the year in the Julian and Gregorian Calendars, the fourth and last of four months to have a length of 30 days, and the fifth and last of five months to have a length of less than 31 days. November marked the ninth month of the ancient Roman calendar.
Fundamentals of Annuities
I have been asked several times about annuities and the value they can add to an investor’s portfolio. Vanguard describes an annuity as a financial product used by investors to save tax-deferred for retirement or generate regular income payments, helping to replace a regular paycheck in retirement. Years ago, individuals had pension plans (also known as defined benefit plans) guaranteeing them a specific amount of income while in retirement. Pension plans were a great way of securing income during retirement. The issue with pension plans is that the sponsoring company is responsible for remitting payments. So once someone retires, the company is on the hook to pay this individual, which in turn taps into the company’s earnings. Because of this obligation, many companies have since gone away from offering pension plans and more toward offering retirement plans that are not guaranteed by the company. Annuities are a way for individuals to have a steady stream of income while in retirement.
It is worth noting that annuities are offered by insurance companies, but are sold by financial professionals in banks, insurance companies, and investment firms. There are two basic types of annuities, which are categorized as deferred or immediate. Before I get into the explanation of deferred and immediate annuities, I think it’s worth explaining a few basic points on annuities. Within an annuity contract (or agreement), there are several items to pay close attention to, including the structure of the annuity, provisions such as spousal, beneficiary, or survivorship clause, withdrawal penalties and guidelines, interest rates, and the surrender charge. It is also important to understand there is key terminology to pay attention to, such as contract owner, annuitant, contract number, and beneficiary. The contract owner is the individual who buys an annuity. An annuitant is the person whose life is used as the measuring point for determining when benefits payments will start and cease. The contract amount is determined by the term of the annuity as well as the dollar amount invested. The beneficiary is the person who is entitled to the money in the contract when the annuitant passes away. Each of these components is important to understand before getting into an annuity contract. You should certainly seek the advice of a licensed financial professional before moving forward with the purchase of an annuity. With that said, let’s discuss deferred and immediate annuities.
Now there are a few different types of deferred annuities, such as fixed, variable, and equity-indexed. Deferred annuities typically are categorized by the way income is paid out to the annuitant. Essentially, the annuity payments start after a lapse of a specific period of time after the purchase premium was paid. However, you are not required to start paying taxes on the annuity until you begin taking withdrawals from the annuity.
For fixed annuities, the interest on the annuity is guaranteed by the insurance company and the insurance company typically discloses what that interest rate will be. An easier way to explain a deferred annuity is that it’s much like a bank certificate of deposit. Fixed annuities are typically for those who are more risk adverse, while variable or equity-indexed annuities are for those who are not as necessarily risk adverse. Interest on variable and indexed annuities typically credited to the separate account are not in fixed amounts. In fact, the interest may fluctuate based on a few factors such as: market performance and separate account performance. These types of annuities interest mirrors or track a certain market index. They may also invest in bonds and other equity portfolios as well.
Immediate annuities are just as they sound – immediate. These types of annuities are often purchased with a single payment and guarantee a stream of income that starts almost immediately. Immediate annuities are also known as single premium immediate annuities (SPIAs), which are typically a good choice for retirees who are concerned about outliving their income. However, a concern with this type of annuity is that the premium paid is held in house with the insurance company and is not paid out to beneficiaries.
As a recap, consumer sentiment looks good as we approach the month of December. However, if the trade war with China continues to lag into December (or even next year), we could start to see considerable uncertainty in the markets.