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Farewell Mr. Bogle

The Days Ahead: More earnings. Many government stats aren't available because of the shutdown.  

 One-Minute Summary: Another good week. Year to date, 459 companies in the S&P 500 are up and 50 are down. That’s an even better dispersion than a week ago. Only two companies are down more than 8% and they are Macy’s and the hapless PG&E. Neither is a surprise. Some of the biggest rises are in companies that were hit badly in the last two years and are on a bounce from record lows.

 Which reminds us of financials. They had a good week after earnings from Citibank, JP Morgan and Bank of America. The bar was very low. The market turmoil of the fourth quarter had everyone braced for bad news so when management gave more upbeat forecasts the sector rallied by 6%. Financials have had a rough time in the last 10 years. New regulation, higher capital, low interest rates and fines have taken their toll. As an investment, they peaked in 2007 and have yet to make back their highs. They’ve underperformed for the last five and one-year periods. They’re never going to be exciting investments again but at least some confidence is finally back.

 The market was driven by three things.

One, the Fed again urged patience with rate hikes. What was interesting was that the latest call for waiting came from the most hawkish member of the FOMC, Esther George from the Kansas Fed. Since 2011, she’s been on a crusade to raise rates, so this was a big turnaround.

Two, trade progress. Well sort of. You know how news comes out from the White House. Long on promise. Short on details. Anyway, it seems as if China is nearer to a deal and even committed to bring the U.S. trade surplus to zero. To do that they would have to buy all their aircraft from Boeing, all their soybeans from the U.S., double their auto purchases, use U.S. fabricated semi-conductors, move a lot of plants offshore and the U.S. would have to stop buying cell phones. Could happen.

Three, a very benign bond market with 10-Year Treasuries around their lows for the last 12 months.

It’s one of those markets shrugging off bad news and jumping all over good news. The reverse of three months ago. But the basic themes are stocks holding up, earnings OK and an easier Fed.

1.     Oh, no they didn't.  Yes. Surprisingly, the White House underestimated the economic impact of the government shutdown. No problem calculating 800,000 furloughed workers. That works out at 0.01% of GDP for a two-week shutdown. But we’re at a month now and they forgot to calculate the 4m or so Federal contractors who, while not government employees, are out of work. Here’s the top White House economic advisor saying workers are actually better off because they're not working. Now, I don't know from under what stone crawls the idea that not working improves people’s economic well-being, but suffice to say, no, Kevin, it doesn't work like that.

So what’s the real number? Tricky but here are some things we know:

  1. The 2013 shutdown was 13 days and it cut GDP by 0.3%

  2. Federal government employee compensation, for around 2.8m workers, is around 2.1% of GDP. That’s $420bn.

  3. Around 380,000 of the 800,000 are furloughed without pay. That means they don't get paid for when they're off work. The others will have pay reinstated for the time off.

  4. So about 20% of all workers are without pay, which they'll never get back, which is about $76bn. Another 20% will be paid when it all ends.

  5. Put all that together and we’re looking at a 0.9% decline to GDP

  6. Add in private contractors, government purchases and a multiplier effect and we’re at -1.1%

All those numbers are reductions from trend growth, so that means 1.1% less than what would otherwise have been a 2.5% quarter.

So, what about the actual level of growth?

We know that Q1 GDP has displayed some weird seasonalities since the crisis. For 8 of the last 10 years, Q1 was the weakest quarter of growth for the year, although in 2013, it was later revised up. The first estimate of Q1 GDP is not due until late April but we think we're headed for a negative number. That’s assuming the shutdown has ended because the BEA, which runs the GDP data, is, you guessed...closed. That will put the Fed very much on hold.

 2.     So, consumer confidence holding up? Er, The latest report on consumer confidence took a nosedive and is at its lowest level since the election in October 2016.

The decline was due to…well the University of Michigan said it best, so we’ll hand over to them:

“…to a host of issues including the partial government shutdown, the impact of tariffs, instabilities in financial markets, the global slowdown, and the lack of clarity about monetary policies”

Now, the reason the stock market hasn't freaked out is because:

  1. Sentiment and spending are not the same

  2. The market corrected a lot in 2018 and, as we said at the time, it was probably overdone

  3. Inflation expectations remain low, so the Fed is likely to stay its hand.

Of course, that may all change but for now it’s steady as we go and avert your eyes from the government and political train wreck.

3.     Jack Bogle. Died. The pioneer of index funds. There are plenty of good obituaries, here, here, and here.  The story is well-known by now. How he took a simple concept, just buy all the stocks in the S&P 500 weighted by their size, hold on and don't pay high management fees. Initially it was all a failure. The original S&P 500 fund from 1976 only raised $11m. Today it's $420bn. Back then the average fee for a managed fund was around 1.2% and you had to pay 5% upfront to buy it. So, a $100,000 investment would cost you around $26,000 over 10 years. With Vanguard it now costs $740.

No other person has done as much for personal investing as Mr. Bogle.

Bottom Line. It’s been a great start to the year. But so was 2018, so no counting yet. The S&P 500 is back to October levels so anyone who went to cash back then has missed a 14% bounce.  Small company stocks have done even better and international and Emerging Markets have kept pace with the S&P 500 over the last few weeks. The Treasury market has held up well. And will remain so. The Fed has no real data to work with and so will stay on the sidelines.

Please check out our 119 Years of the Dow chart  

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--Christian Thwaites, Brouwer & Janachowski, LLC

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