The Current Stock Market Environment Reminds Me of a Hurricane

We need to remember that, at some point, the market will return to its unfinished business from late last year.Investment markets can be confusing. To try to cut through the chatter and investment slang, we present this monthly view to you. We want to give you a 50,000-foot view of market conditions updated as our view evolves. Currently, our Investment Climate Indicator remains at Stormy. Stormy means that bear market rules apply, and we believe could be a period of wealth destruction.

It’s quiet. Too quiet.

As I mentioned in last month’s report, the current stock market environment reminds me of a hurricane. Specifically, the eye of the hurricane — the sunny, calm respite between the front and back sides of the storm. The month of April did nothing to change my mind. And as the S&P 500 fell more than 1% in about 90 minutes on the first trading day of May, we must keep reminding ourselves that at some point, the market will return to its unfinished business from late last year. While many investors appear to have forgotten already, the S&P 500 fell over 15% in 3 weeks last December, and only a Christmas rally (miracle?) kept that index’s losses for the full year 2018 to 4.4%. As of Christmas Eve, the S&P was down over 10% for the year.Why go back to all of this recent history? Because there is a sense among many veteran market watchers (including yours truly) that fear has left the building. Or, to put it another way, the only thing we have to fear is missing out on more great stock market returns. And that, otherwise known as FOMO (fear of missing out), is creating a kind of investor uneasiness that is most reminiscent of the dot-com bust of 1999-2003. The biggest mystery is that we just don’t know how close we are to the end of the long bull market for stocks. And while some would argue we are closer to the beginning than the end, and that the bull will run forever … well, let’s just say that while anything is possible, I’d prefer to keep emotions at bay and recognize that we are more likely in the eye of the storm than in the clear.A lot of what determines how much can be squeezed out of the old bull before the bear moves in has to do with the economy. Specifically, when will a recession arrive, or at least enough of a threat of one to stir investor emotions. After all, with algorithmic trading and index funds continuing to dominate trading activity, the emotional side may be all that matters. And the Federal Reserve continues to keep investors guessing about what their interest rate policy will be. This is a game that Wall Street plays with itself, but it is no game when it causes the value of your investment portfolio to be tossed around as it was through portions of last year.Earnings season has been quiet as well, for the same reason it often is, because companies get graded on a curve. As Lance Roberts, chief portfolio strategist of Clarity Financial, said recently: The routine is for Wall Street analysts to reduce earnings estimates, perhaps multiple times, until the estimates are so low that most companies end up beating them. Roberts compares this to youth soccer, such that earnings season is now a game where scores aren’t kept, the media cheers, and everyone gets a participation trophy just for showing up.So yes, it was pretty quiet out there as the first four months of 2019 ended. But continuing the sports analogies, hockey is a three-period game, and as avid fans know, the first period is the one where there is a lot of activity, but the most meaningful events tend to occur later on. Given the combination of market stimuli, it would not surprise me at all to see 2019 follow a similar script. It won’t be quiet forever, and I suggest using this time to evaluate whether you are sufficiently set up to continue meeting your objectives should things get louder.

Stock Market

In April, the S&P 500 Index rose 3.83%, its second-best month of the year. The index is now up in each of the four months. It is worth noting (especially for those who think that all I do is find a way to put a negative spin on stock market gains) that this is the ninth time that has happened since 1990. Each of the other eight times, the market finished up for the year. It is also worth noting that in each of the S&P’s down years since 1990, at least two of the first three months of the year were negative. So, if that past is prologue, 2019 should be a positive year for stocks.

Bond Market

The bond market is getting weird. As the chart above shows, the yield on a 6-month U.S. Treasury Bill about equals that of a 10-year Treasury Bond. This doesn’t happen often, and when it does, it typically means the economy is building toward a recession. But since April ended with media chatter about the possibility that central banks have put an end to recessions, perhaps we should talk about something else — until the next recession arrives.

Key Market Stress Points

  • Valuation — Stocks are still historically overvalued, with the Shiller CAPE version of the price/earnings ratio near its 1929 level. The S&P’s 10-year return is in the top 4% of its range of the past 60 years.
  • Index mania — Assets continue to pile into S&P 500 index funds, creating a mirage of safety in numbers that will likely be a key contributor to creating the next bear market panic.
  • Credit — Mortgage debt is approaching its 2008 peak. Massive growth in consumer credit is unsustainable.
  • Bond market risks — approximately 50% of bonds in “investment grade” bond funds are rated BBB, the lowest of the 4 possible rating categories. This is like when too many people try to jam onto the subway car.
  • Sentiment — IPO-fever is intensifying, a la the Dot-Com era
  • Geopolitical — Trade talks are in limbo, and U.S. political wrangling continues unabated.
  • The Plan

    My portfolios remain toward the middle of the risk spectrum, rather than near bullish or bearish end points. Defensive investing should be front-of-mind, but the possibility of a melt-up in the stock market is still very real.As I have stated before, I am not a bull or a bear, I am a realist and a devout risk-manager. And from 2009 through 2019 (so far), risk-management has been just something talked about. But as debt builds unchecked at the consumer, government and corporate level, geopolitical strife mounts, and the middle class continues to vanish, we have to be on guard for the break in confidence that in reality, is as responsible for today’s lofty market heights as anything. Be careful, understand what you own, and respect the laws of gravity.Look closely at the returns of SPY and EFA over the past year. That’s some spread between them. Another reminder that it’s a big wide world of stocks out there, but investors increasingly concern themselves only with the big ones (50-75 of them) that make up much of the S&P 500.REITs and utilities are far from bargains. Their yields are around their lowest levels since about this time in 2008.In one of those unsung signs of a speculative stock market, MLPs (oil and gas pipeline companies) have jumped this year. These companies are moving higher with oil prices, but they have historically been less correlated to oil and less volatile than oil stocks than they have been recently. It’s as if anything that rhymes with equities is coming along for the ride.This year’s recovery from late 2018’s decline has not been a tech-only story, as shown by the S&P 500’s strong performance without that sector (last row of table above).Europe stocks yield nearly double that of the S&P 500 and Japan’s yield almost 2.5 times as much. At some point, this should really matter to yield-starved investors. Future weakness in the U.S. dollar would only sweeten the pot for U.S. based investors.To quote Brooklyn Dodgers’ fans, “Dem bums.” Emerging market stocks with higher yields have only barely broken even during the past year. But as Dodgers fans also used to say, “wait ’til next year.” We’ll see.The gyrations of the stock market during the past 12 months have left all four of these portfolio mixes with about the same return, around 5%. That reminds us of how competitive a more conservative portfolio can be when markets get nasty.Oil prices are rolling (not a barrel metaphor) and what the Beverly Hillbillies theme song referred to as “Texas Tea” is hurtling toward its October 2018 high of around $75. If it surpasses that, it will be the highest price since 2014, and could stoke inflation fears.That 1-year return of the 7-10-year Treasury ETF is its best in about three years. But the yield is still fairly low. Translation: don’t expect bond returns to approach that level too often in the years ahead.Senior Loan funds probably look very tempting to investors. But when you consider that 1-year returns of that market segment have rarely crossed above 5%, that 7% return in four months must be put in perspective.Source for all ETF data: Ycharts.comDisclosure: This material contains the current opinions of the author, Rob Isbitts, but not necessarily those of Dynamic Wealth Advisors and such opinions are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Past performance is not a guarantee or a reliable indicator of future results. Investing in the markets is subject to certain risks including market, interest rate, issuer, credit and inflation risk; investments may be worth more or less than the original cost when redeemed. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Rob Isbitts offers advisory services through Dynamic Wealth Advisors.