10-15 Associates

Will The Consumer Keep Spending?

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There were two themes that dominated the markets for most of the month of August.

The return of volatility would be one and the other would be falling interest rates. The question remains whether the volatility in the markets spooked investors into buying bonds, sending prices higher and yields lower, or if the precipitous drop in yields spooked stock investors who interpreted the drop in yields as a signal from the bond market of bad things to come. The challenge of low volume in addition to continued lack of clarity on trade and mixed signals from the economy was the perfect recipe to result in 12 consecutive days that the S&P 500 moved by more than 1% intraday in either direction. Ten-year treasury rates saw lows not seen since 2016 and the 30-year treasury yield dropped below 2% for the first time ever. Given the volatility and the losses midmonth, the final tally for the month was not as bad as it could have been.

The S&P 500 was down 1.81%, the Dow down 1.72% and the Nasdaq gave back 2.6%.

For investors that still embrace the theory of diversification, this is a year that proves diversification does work. Perhaps a surprise to many, the bond market has been a powerful source of return for diversified portfolios this year. The iShares Core U.S. Aggregate Bond ETF, which tracks the benchmark for the taxable bond market, returned a positive 2.73% for the month. A portfolio using a 60% S&P 500 and 40% U.S. Aggregate bond index would have been down just .62% for the month. As bond yields decline, bond prices rise. This relationship has turned the traditional thought process upside down. Investors are looking to bonds for the potential appreciation given the low income that they offer, and they are looking at stocks for the income. The yield on the S&P 500 moved above the 10-year treasury on August 5th, providing a competitive income, which read as a signal that stocks are very often undervalued.

The decline in rates was dramatic across the entire interest rate curve during the month. Two-year yields declined by 19.6%, ten-year yields declined by 25.73% and 30-year yields dropped by 22.27%, sending mortgage rates to new lows. For those in the market for a new home, or those thinking of refinancing, now is the time to get serious. Lower rates can act as a stimulus as homeowners take advantage of the ability to refinance and pull out equity or reduce their monthly payment. Even before the declines that we saw in August, according to Freddie Mac, 8.2 million borrowers could refinance and lower their interest rates by at least 75 basis points. The average borrower could save about $266 per month, creating a total potential savings amount to about $2.2 trillion. It is also estimated that there is nearly $6 trillion in tappable equity, which is generally considered the value of a home beyond the 20% retained equity most lenders require. Of the 44 million borrowers who currently have a least 20% equity in their homes, the average amount they can tap is $136,000 according to Black Knight, a mortgage software and analytics company.

Keeping the consumer engaged is a key to the momentum of the economy this year. The big question for investors today is how long it will last. A small decline in consumer confidence was enough to catch investors attention. Household spending ramped up in July providing some reassurance that the economy’s decade long expansion was still intact. However, the prospects for continued strong spending ahead are less clear. The drop in consumer sentiment was the largest drop since 2012, and with new tariffs about to go into effect, questions about the continued strength of the consumer loom large on investors minds. Businesses are already on edge: as expressed by Tara Riceberg, owner of Los Angeles area gift shops, who suggested that her customers “shop now for Christmas because I’m getting emails from all my vendors that they are going to increase prices starting in September.” Price hikes as much as 30% on some products are anticipated as the full impact of the new tariffs become reality.

As we reluctantly close the books on another summer, one part of the economy that remains extremely strong as been travel. Whether by car, train or plane, the numbers are clear: people were spending money to travel. Beginning with the Memorial Day holiday right through the Fourth of July and Labor Day, a record number of people were on the move. If you were one of the many stuck on the roads or stranded at an airport for longer than expected, take heart you were not alone. A record 17.5 million passengers were expected to travel on US airlines alone. Airlines carried an estimated 2.51 million passengers per day for the week-long period including Labor Day. This represents a 4% increase over last year. As many as 25% of Americans traveled over the holiday weekend, thousands packed college football stadiums and more that 102 million enjoyed a cookout. The 7.5% decline in gas prices from a year ago helped the 86% of travelers that opted to get to their destination by car. The average household spent $2,737 on their summer vacation according to Wallet Hub. For those of you that are fans of the Coney Island hot dog eating contest you may be interested to know that 818 hot dogs are eaten every second from Memorial Day to Labor Day.

That brings us to September, which, according to the Stock Traders Almanac, has been the worst month of the year for both the Dow Jones Industrial Average and the S&P 500 since 1950. The Nasdaq is not exempt from the September phenomenon, and since its inception in 1971, it has fallen an average of .5% during the month. Although there is no direct correlation to news or specific events, and is explained more as seasonal behavioral changes, it is a month that brings with it some trepidation. With the economy beginning to show some signs of slowing and the trade war still unresolved, it is likely the volatility will persist as the market searches for some sound footing. Once again, we will be looking to the Federal Reserve for confirmation of further easing and more data on the health of the economy.

Long term investors are always reminded to focus on the long term and not to get caught up in the day to day headlines and short term moves in the market. One statistic I came across at the end of August and thought put this in perspective was the move in the market over the last 12 months. We have been through three corrections over the last year including the 10% drop we experienced in December, yet if you look back a year, the Dow was at 25,964 and it closed this month at 26,403. We have traveled a lot of distance day to day to be where we were a year ago!

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