Where Are We, and Where Are We Going? A Mid Year Update on Markets & The Economy

As the volume and pace of news continue to increase, it’s easy to get distracted from the opportunities and also the pitfalls that are before us. To help you keep your focus on your long-term financial plan, our team has developed and refined an investment process that is not dependent on forecasts, predictions or market timing.

Our process is focused on a customized asset allocation based on your current needs and long-term vision. Still, it is interesting, if not psychologically important, to get a sense of where we are and where we are going with regard to financial markets, the political landscape and the economy.

The Markets: We Predict a Correction

We believe a near-term correction is likely in the broader equity markets as people (ironically) become concerned about how well the economy is doing. Fear of higher inflation due to better corporate earnings, low unemployment and higher FED funds rates could be the trigger for this correction. We view this as healthy and not a reason for concern if you are invested properly.

We believe the coming drop could be 5 to 10 percent of the broader equity markets, followed by a strong rebound in the fourth quarter. Overall, we believe 2018 will be a good year for broader equity markets when all is said and done.

Over the years, one common mantra has been “Sell in May, and go away.” The idea is that the stock market goes into a slump in the summer, and activity picks up again after Labor Day. We do not believe in market timing or that you should adjust your portfolio in anticipation of a correction.

We also believe that interest rates will continue to rise and that we will see long-term taxable bond prices drop. Tax-exempts might be less impacted as the supply of quality tax-exempt bonds continues to be reduced.

Politics: November Will Be Key

It will be interesting to see what the outcome of the mid-term elections is. As we get closer to the mid-terms on November 6^th, we will no doubt hear more from both sides about all the problems we have — the candidates and political parties all want to justify their bid for election.

Elections will be held for all 435 seats in the House of Representatives, the lower chamber of Congress. These are contested every two years, both alongside the presidential race and in mid-term elections. Also, 35 seats are up for grabs in the Senate, the upper chamber, which holds elections every two years for about one-third of its six-year positions.

In early May, six months ahead of midterm elections, data from registered voters across the country suggested that Republicans held a slight edge on the generic ballot in key Democratic states, including Florida, Indiana and Missouri. That indicates that voters in those states are ready to replace incumbent Democrat Senators. Slightly more voters said they would vote for a Democratic candidate (40 percent), compared to 35 percent for a Republican candidate, according to a report by Morning Consult, a company that specializes in online survey and market research.[1]

However, pundits who are prognosticating about the midterm results seem to make predictions based on their political leanings. So you can find just as many articles predicting that the Democrats will come out ahead in November as you can find predicting that the Republicans will prevail.

“Politics is not worrying this country one-tenth
as much as where to find a parking space.” —Will Rogers

The Economy: It’s All Good!

The indicators are some of the best we have seen in years. The one area that concerns some is the level of the federal deficit and debt. In our opinion, this is not a threat to the growth of the broader equity markets over the next few years because we have already seen massive tax cuts and regulatory reduction, which should help offset the debt as they begin to have an impact later this year.

The unemployment rate is the lowest since 1969, while inflation, as measured by the consumer price index, or CPI, remains low. The gross domestic product (GDP) is a monetary measure of the market value of all final goods and services produced in a period (quarterly or yearly) of time. GDP growth appears to be accelerating, and in our opinion, will move up as the tax and regulatory cuts have an impact. S&P 500 earnings per share jumped by more than 9 percent in 2017, according to FactSet, and are expected to grow even more in 2018. We are seeing record foreign investment in the United States. We expect U.S. companies to continue to repatriate funds that have been held overseas.

Global companies cashed in on newfound economic strength in Europe and Latin America as well as relative stability in China. For the first time in years, virtually all major global economies are growing at the same time. “During 2017, the global synchronized recovery turned into a global synchronized boom that is likely to continue in 2018,” Ed Yardeni, president of investment advisory Yardeni Research, wrote.[2]

Companies continue to accumulate record levels of cash, which can be deployed as higher dividends, bonuses and capital investments or stock buybacks. Any and all of those can help the broader markets and economy grow. Non-financial U.S. companies are sitting on an estimated $1.9 trillion in cash, more than double their 2008 totals, according to Moody’s. Corporate earnings were up 25 percent in the first quarter of 2018 versus the first quarter of 2017.

In May, jobless claims fell to the lowest rate since 1969. At the same time, continuing claims have averaged the lowest since 1973. In the past year, non-farm payrolls are up an average of 190,000 per month, matching the pace of the year ending in April 2017. Assuming a real GDP growth rate of 3.0 percent this year and next, we think the jobless rate could finish 2018 at 3.7 percent and then drop to 3.2 percent in 2019, the lowest since 1953.

Two Areas of Concern: Debt and Trade Wars

Two areas of concern that continue to be highlighted by the media and doomsday soothsayers are the federal debt and the possibility of a trade war due to tariffs.

We have heard that the federal debt is growing to growing to unsustainable levels and destroying the U.S. economy for more than 30 years. While the absolute dollar amount of the debt continues to rise, the impact remains benign. Back in 1981, the public debt of the federal government was $1 trillion; today it’s more than $21 trillion. At some point, the theory goes, additional debt is going to be the fiscal straw that breaks the camel’s back. The problem with this theory is that, in spite of the record-high debt, the net interest on the debt — the cost to our government to satisfy interest payment obligations — was only 1.4 percent of GDP last year, hovering near the lowest levels in the past 50 years.

We believe that GDP will grow 3 to 4 percent, given the tax and regulatory cuts. Even if this is not the case and interest rates double on the debt, we would be well within historic norms. Doubling the interest rate to 4 percent would mean net interest relative to GDP would double as well, going from 1.4 percent to 2.8 percent. That certainly wouldn’t be pleasant, but it would be no different than the average net interest on the national debt from 1981 through 1999.

We also are hearing more concerns about a trade war due to the threat of tariffs by the United States. No doubt as we approach the midterm elections, this refrain will continue. We believe this is simply a negotiating tactic that might cause short-term volatility but will not have any longer-term impact. Other countries need the United States, and we do not foresee a trade war.

“No nation was ever ruined by trade.”—Benjamin Franklin

Protect Yourself from Inflation with Increased Income

We are not saying everything will be perfect. There is often a difference between good economics and social impact. We believe that higher inflation and a drop in fixed income values will impact many who are not invested properly. Those who react to any short-term market corrections and/or have too much fixed income will not benefit, and might even lose, despite the strong markets we expect. We will continue to hear more about technology replacing jobs and all the problems due to either a stronger or weaker U.S. dollar.

We have seen a decades-long trend of relatively low inflation, and now we might be at a point where this reverses. The 40-year trend of falling inflation was primarily generated by healthy global demographics, globalization, automation and central bank policy. Falling inflation translated directly to lower bond yields and provided fuel to rising equity and credit markets.

As inflation rises, the cost of everything, from food to utilities, goes up. To help protect your standard of living, your income must rise commensurately. It is important that your portfolio is positioned to generate growing income rather than fixed income. In this regard, we believe that fixed-income investments such as CDs and bonds might pose significant risk to people’s ability to maintain their lifestyles as the cost of goods and services increases and, in some cases, bonds lose value.

This is why we monitor and update your portfolio —we must recommend adjustments to help meet your changing personal needs that are not based on past assumptions or rules of thumb.

We believe demographics will play a role in pushing inflation higher. Census data mark 2018 as the year that inflation demographics turn in favor of higher inflation as dependency ratios finally begin to rise after falling for several decades. The “age dependency ratio” is the ratio of dependents (people younger than 15 or older than 64) to the working-age population (ages 15 to 64). A growing body of research suggests a strong causal link between demographics and inflation. For instance, a recent Bank of International Settlements (BIS) study found a direct relationship among the working-age population, the number of dependents (both young and old) and the underlying trend of inflation.

The study strongly suggests that inflation retreats as the number of dependents decreases, relative to the working age population. This demographic condition is known as a “falling dependency ratio,” and it characterizes the U.S. experience since the 1970s, as the baby boomer generation moved through their work/life cycle.

Conversely, as the dependency ratio increases — as it did through the 1950s, ’60s and ’70s — there is a strong likelihood that the underlying inflation rate will increase.

As Always, We Are Focused on Your Current Needs and Future Vision

Our entire team continues to focus on helping to provide you with the income you need to do what you want today while working to grow your portfolio to help you maintain and enhance your lifestyle in the future. We monitor and update your personal and customized portfolio allocation based on your needs and on changing tax laws. We are focused on net returns after fees, expenses and taxes, and we take a very proactive approach. It is important to have realistic expectations with regard to both income and return. We are here to help you craft a long-term plan to assist in meeting both your current goals and your long-term needs and vision.

Never has the pace of change, or volume of news, been this great, nor will it ever be this slow again. Our experienced team is here for you, whatever the future brings. Although we might not contact you, we are monitoring both your portfolio and events that might impact you. Our team is committed to continuing education so we can provide you with cutting-edge salutations. We use a team-based approach with highly qualified people who have both the training and experience to help you develop your vision plan.

We meet with thought leaders personally so we can understand what might impact you, without going through the filter of the media or other third parties. Other companies use cookie-cutter solutions for portfolios and rely on third-party information and research. Some companies are even using technology to replace staff and reduce personal contact with their clients. We believe that you should have a fully customized experience, so we continue to grow our team and use technology to provide a more personal experience, not less.

We appreciate being your partner and look forward to continuing to serve you. Please contact us whenever we can be of service to you, your family and friends. We are taking clients only by referral but are happy to meet, without cost or obligation, with someone you feel would benefit from our personal vision planning™ process. We are here for you. Please contact us without cost or obligation to discuss your personal goals, to provide a second opinion on current financial and wealth planning or if we can otherwise be of service.

Randy Carver – randy.carver@raymondjames.com

www.carverfinancialservices.com 7473 Center St. Mentor OH 44060

440) 974-0808