May 2019 investment outlook
Bob Landaas: Kyle, as you know, the stock market’s off to a really good start for 2019. Pretty rough fall last year, and then the Federal Reserve does an abrupt 180. No one thinks that the Fed’s going to raise interest rates anymore—at least for now, and the market’s up 17%.
Kyle Tetting: And not just enough, Bob, to point at stocks, but also you look at the bond market, and I think so many investors had maybe assumed that bonds were going to give a little bit back this year if the Fed did continue to raise. And then, as you mention, maybe getting a little help from the Fed in the bond market as well. And bonds are off to a really good start to the year, too.
Bob: I’m always so impressed at how predictive the stock market is. With the decline that we saw, with the NASDAQ in bear market territory temporarily last fall, suggesting that we were going to have an earnings recession, which we did for the first quarter of the year. Not everybody’s reported in, but give or take, they think earnings are going to be down 3% year-over-year. The market came roaring back this winter and spring, in part because they think earnings by the end of the year are going to be up 8% or more.
Kyle: And it’s so important to remember the leading indicator that is the stock market. It’s so important to remember that markets are anticipating what’s going to happen down the road. And so, certainly the expectation for an earnings recession in the first and second quarter weighed on stocks last year, but I think the expectation for where we head from here is a bit more positive.
Bob: The government released a GDP report—at least the first estimate of it—for the first quarter: A pretty big number, over 3%. You look under the hood, though, maybe not as good as folks think. We had considerable inventory builds. So fine, you’re stocking your shelves, but it doesn’t result in final sales. Sometimes companies just sell out of inventory, which is a reduction of production. The government spent more money on highways in the first quarter, and then finally we had more exports than imports—that adds to GDP. They think if you subtract all of the factors out, maybe we only grew about 1% this last quarter.
Kyle: Yes Bob. I think it’s so interesting to look at the typical GDP report and see how it’s constructed, right? We often talk about how two-thirds of GDP growth comes from consumption, from personal consumption. And yet, you look at as you said the components of this GDP report, a lot of that growth came from areas that we’re not used to seeing being big contributors. In particular, the exports piece. In particular, inventory build. And that could have some impacts down the road.
Bob: As you know, economists are terrible at forecasting recessions because of how difficult it is, but we can tell trend line. And GDP has been declining. We had 3% growth last year, maybe two-ish percent this year, and the forecasts call for perhaps even a slower growth next year. Things look fairly good here in the United States, but overseas, not so much. You’ve got this significant slowdown in Germany now, Europe’s largest economy; Japan continues to cycle in and out of recession; and then we have, of course, the big wildcard of China, and they continue to slow as well.
Kyle: And, Bob, you know you are fond of saying that we haven’t had a recession start here in the U.S. caused by something that happened overseas, that we tend to be the one that leads the world into those issues. And yet, you mention all these things that are going on around the world that might be a problem. It’s encouraging to see that eurozone GDP came in in the first quarter a little bit better than expected. And yet at the same times, a bit better than expected is maybe a bit better than 1%, not the 2 or 3% that we’re seeing here in the U.S.—even if there’s a bit of nuance to that number.
Bob: Clearly, one of the biggest bargains in the investment world is emerging market stocks. Some valuations show that they’re at a 30-year low relative to U.S. stocks. Kyle, I think they’re cheap for a reason, with a lot of those economies dependent upon selling raw materials to China. China’s not calling them as much as they used to. It seems like that’s going to be a while before that turns around.
Kyle: And I think investors need to remember what they’re really looking for in the emerging markets is the opportunity to purchase the growth of the consumer there. That if you look at consumption in emerging markets compared to much of the developed world, you’re talking about a consumer base that just doesn’t have the disposable income yet. There are other ways to do that than to buy those companies domiciled directly in the emerging world. There are all kinds of great companies here in the U.S. and in other parts of the world that sell to China, that sell to Africa, that sell to parts of Asia, that maybe have a little bit more attractive growth. And so, you don’t have to go necessarily towards those commodity producers, towards those commodity exporters, to get exposure to those markets.
Bob: The Federal Reserve raised interest rates starting in December of 2015. They stopped in December of last year. As I mentioned a bit ago, it’s widely assumed that the Fed’s not going to be raising anytime soon. The futures market in Chicago suggests there’s a chance, pretty good chance, that the Fed could even lower by year-end. I think it’s finally time for investors to extend durations on their bonds. You and I moved a lot of money out of the low end of the bond market—credit quality, non-investment grade, triple-B, the bottom end of investment grade. And now, I think it’s time to extend durations so you don’t get renewed at a lower rate.
Kyle: Such a great point, Bob. I think we spent a lot of time trying to avoid the impact of rising rates. Obviously a bigger impact on the longer end of the yield curve on those longer-dated bonds, and now we’re in a very different environment, as you say, than what we were in. So I think absolutely an opportunity to extend durations, keeping in mind that you still want to focus on quality. I think those two pieces will be key to fixed income.
Bob: It’s all about interest rates and earnings. As you know, interest rates are on their way down. That’s good for stocks. On an earnings front, I think investors just need to look past this last quarter, perhaps this current quarter, and realize that earnings are expected to accelerate into a pretty decent range—8%, 9%, 10%—for later this year into next year.
Bob Landaas is chairman and chief executive officer of Landaas & Company.
Kyle Tetting is director of research and an investment advisor at Landaas & Company.
Money Talk Video by Peter May and Jason Scuglik
Recession suggests balance, a Money Talk Video with Kyle Tetting
Global exposure via large U.S. companies, a Money Talk Video with Marc Amateis
Ignore bonds at your own risk, a Money Talk Video with Kyle Tetting
Spring 2019 Investment Outlook, a Money Talk Video with Bob Landaas and Kyle Tetting
Forecasts suggest an earnings recession, a Money Talk article by Joel Dresang
(initially posted May 3, 2019)