March "Insanity"

Hello Friends!

March - a wonderful month to enjoy college basketball and avoid silly trademark infringement. How are all of your brackets doing? You’ll be fine as long as you picked Michigan as the national champion. Go Blue!

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Spring is around the corner, which means it’s time to do taxes, clean up the messiness that’s piled up over the winter, and get some extra sunshine. After a somewhat rough season at work, it’s good to be back and writing. Cheers to jumping back on the train and back on the grind!  

Fed
Last Wednesday, the Fed announced that they would keep the Fed Funds Rate steady at 2.5%, with a target of one more hike either in 2020 or 2021. This represents a pretty substantial pivot from the previous stance in Oct 2018, when Fed Chair Jerome Powell said that the funds rate was still a “long way” from neutral. Those comments sent the stock market tumbling, as investors feared that Fed policy would ignore a weakening global economic condition. Think of it like the Spurs organization making Kawhi play before he felt fully recovered from his quad injury. We all know how that played out.

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The Fed also announced it would end its balance sheet unwinding in September. (OK, now in plain English, please). During the 2008 Financial Crisis, the Fed took measures to try to save an economy that was quickly collapsing. By buying huge amounts of bonds and mortgage-backed securities (quantitative easing), the Fed took on the risk of default on this debt and provided some much-needed liquidity in the market. This massive Fed shopping spree is what led to a bloated balance sheet. As bonds reached maturity, the Fed would continue buying more bonds to replace the ones that rolled off. With less risk, more cash, and an extremely low interest rate, the economy got back on track. People and businesses went back to spending, because idle cash pretty much didn’t earn anything.  

After a decade-long bull run, the Fed had been unwinding its balance sheet by letting bonds mature, but not buying back more to replace those. This then reduces market liquidity and has the opposite effect of quantitative easing. The Fed announcement to stop unwinding its balance sheet means that they will get back to buying more bonds as maturing bonds roll off. In other words, the macroeconomic outlook does not look good.

The market response was…
…good, and then not-so-good. Kind of like the Lakers signing Lebron and then failing to make the playoffs this season (oops, too soon?) Usually, equities get a boost if the Fed Funds rate remains low. Raising rates makes bonds more attractive, so a stable forecast for the next two years on the Fed Funds rate would normally provide a boost to equities (as they would be comparatively more attractive). Following the announcement on Wednesday stocks soared on Thursday, and came crashing back down Friday.

 So what happened? The treasury yield curve saw another major inversion, with the 3-month treasury yield outgaining the 10-year yield. That’s obviously concerning, because you should theoretically be rewarded more for keeping your money tied up for 10 years vs. 3 months. The inversion is also one of the more reliable indicators of a coming recession (in 12-18 months). In addition, global markets continued to show major weakness, with Germany’s bond yields dipping below zero, and Japanese bond yields inverting as well. Combined with the ongoing geopolitical risks - the global economy is slowing, people are starting to freak out a little, and it’s reflecting in this week’s market volatility.

All right, enough info for today. Just tell me - Should I continue investing in 2019 if recession is coming?
Well, let me ask you first – are you retiring in the next 7-8 years? No? Then keep investing, buddy.

Like many people have mentioned, assuming you are earning the market average return, your investments should roughly double in value every 7-8 years. This market average return includes recessions, by the way. With time on your side, then the prudent thing to do would be to continue investing in some combination of total market ETFs, dividend ETFs, and bonds. There will always be downswings and pullbacks, but the key is to avoid the temptation to panic-sell and to stay the course. There are stories of people who panic-sold their investments in 2008 and 2009, and never jumped back into the market for fear of another sell-off. 10 years later, they’ve still never recovered from that loss, even though most could have recovered if they were well-diversified and just waited things out.

My personal outlook for 2019 is that we will continue to see economic expansion, albeit slower. Is recession on the horizon? Perhaps. But with the huge pullbacks we saw in 2018 (the market still has not climbed back to its previous all-time high), we probably won’t see recession in 2019. But you never know.  

And even if we do, I’m not concerned. In fact, I might even be glad (from an investing standpoint), because it would mean I have the opportunity to buy investments on a much lower cost basis. However, as I’ve mentioned before, if the state of your investments give you great anxiety, then it would probably be better to keep it in a high yield savings account or money market fund.

Issawrap! I hope everyone’s been off to a great start to 2019. Let’s keep the momentum going into Q2.  

-Ezekiel Emunah

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