Amber Lights Are Flashing: A Time for Caution



Volume 90 No. 10 - October 2019


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What awaits us on the economic horizon in 2020? Investors have speculated about the year for many reasons. As it approaches, we wonder what the economy will be like, later this year and in a year’s time. Perhaps more importantly, we wonder how to best prepare right now for what may come.



A Time for Caution


The markets and the economy can never be predicted with perfect confidence and certainty. We all can see the positives—a strong US economy, low interest rates, strong consumer spending, and healthy corporate profits. We can also be honest about the economic factors that concern us like the economic weakness we see globally, uncertainties in trade and in currencies, the upcoming election, rising debt levels, and pressure on wages. Then, there are unknowns like Brexit and negative international yields.

How do all these factors come together and form the tea leaves that can be used to predict the economy in 2020?

The answer: no-one knows. Let’s examine those factors: the positives, the negatives, and the unknowns.



The positives:


A strong US economy – Despite the trade fight with China, the US economy soldiered on, grew two percent in Q2 and is expected to continue to grow at that rate both in Q3 and Q4.

Low interest rates – The cost of money is low. Entering 2019, interest rates seemed to be on their way up – until the Fed dropped rates twice this year and may do so again before year’s end. Low interest rates encourage borrowing and spending, which drive economic growth.

Full employment – It wasn’t long ago that a 4.5% unemployment rate was considered full employment in the US. For August, the Bureau of Labor Statistics reported a US unemployment rate of 3.7%. The August jobs report shows that about six million people are unemployed in the US right now. Compare that to more than 14 million ten years ago in July 2009.

Strong consumer spending – As the Great Recession fades from memory—recent memory, at least—consumers continue to spend with the confidence that has come from a strong labor market and rising wages. It’s so strong, in fact, that it’s compensating for slowing spending on the business side due to the strong US dollar and the trade war with China.

Corporate profits remain strong – Even with the ongoing trade war with China, corporate profits recovered from earlier declines to grow in Q2 this year by 4.8%.



The concerns:


Global economic weakness – Trade protectionism, rising in 2018 and 2019, is disrupting the global economy. While the two big catalysts in that trend, China and the US, return to talks, there’s still concern about Germany’s impending recession, Brexit, and the oil supply coming out of Iran.

Trade and currency uncertainties – As currency markets crossed into October, the US dollar floated at two-year highs against many currencies, including the euro where the dollar traded at its highest levels since May 2017. While the strong dollar reflects world markets’ recognition of the strength of the US economy and its (relatively) high interest rates, a strong dollar makes US exports more expensive and drags down demand for US products overseas.

Election – Elections breed uncertainty over our legislative, fiscal, and economic futures. The 2020 election will be no different. The economy may decide to hold its collective breath while investors, consumers, and companies wait to see who will be charting the course of the economy through 2024.

Wage pressures – At 3.7%, US unemployment is near a 50-year low. That’s good news, but every sun casts shadows. Low unemployment means a smaller pool of workers from which employers draw new employees to fill roles within their companies. Following simple supply and demand, when the supply of workers is low, the price of labor increases, and the US economy has seen rising wages. In August 2019, wages increased by 0.4%. While rising wages can be seen as a positive, they are also an indicator of impending inflation.

High consumer and corporate debt – Consumer revolving debt, which is mostly comprised of credit card debt, topped $1.08 trillion at the end of July, up more than 11% from one year before. While increasing credit card debt indicates increasing spending—and maybe—more confidence in the US economy, it can also mean that more consumers need to use credit cards in order to fund purchases to make ends meet.

Companies worldwide sold record levels of debt in September, driven mostly by historically low cost of borrowing. As in consumer budgets, high levels of corporate borrowing could indicate coming trouble if those companies are relying too much on debt to fund operations, and when a recession comes, they may experience problems with debt repayments.

Equity valuations (P/Es and dividend yields) – Your portfolio is healthy today, compared to how it looked while we were in the throes of the Great Recession. The bull market resulted in some incredible gains in our equity positions. However, many US equities are expensive today when viewed against the fundamentals. Some of that exuberance is certainly warranted; after all, the US economy is outperforming many other economies worldwide.



And the unknowns…


Negative international yields – The economic angst we see in foreign markets has driven more investment to the US, bolstering our financial markets. It’s also a sign of how much investors overseas seek a safe haven for their money. In countries as stalwart as Germany, negative 30-year debt indicates that investors are looking for a safe place to put their money, even if they have to pay for that prospect rather than earn a humble return. Some investors worry about what impact a negative yield curve environment could mean for the US, were it to arise here.

Brexit – If the UK does not secure a third extension in its timeline to leave the European Union, it will become the first member state to ever leave the economic and political union on October 31. The UK has been part of the EU and its predecessor organizations since 1973. Its effects are also not fully understood. While an EU without the UK will add back some barriers to trade, and potentially damage both economies, it could also have effects that spill over into other worldwide economies, including the US.


Conclusion:


No one knows what the future will bring. That old maxim applies to finance as much as to any other segment of our lives. With many economic factors out of our control—like events in other worldwide markets—and many hard to control or predict—like the trade war with China or the coming US Presidential election—it’s hard to know what kind of economy we will find as we enter 2020 and beyond.

We have based Investment Counsel’s investment strategy and approach on two fundamental and complementary tenets:


  1. To preserve the purchasing power of our clients’ principal and interest, and

  2. To focus on the consistent long-term growth of that principal and interest.

For the past decade-plus, we have operated in an economic environment where we focused on growth. Investment Counsel continues to be bullish on the long-term outlook of the US economy and stock market. However, we believe that it’s time to heed the amber lights flashing and change our emphasis to preservation. Over the next quarter we will continue to remain fully invested in stocks, however, we are reevaluating each company to emphasize those stocks we believe can best weather an uncertain market.


Investment Counsel Inc. is a registered investment adviser. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.

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