This really is one of my favorite times of the year and not just because the Masters Invitational Golf Tournament is taking place in our home state. I love this time of year because I get to talk to clients more than any other part of the year. Most of that is in tax preparation but I enjoy the interaction all the same and I always learn something. The theme this year seems to be about retirement. I often get the question "When can I retire?" What is different this year is the question has become - "What is retirement?" Retirement is a relatively new phenomenon. My grandfather retired and was given a pension and social security as his was the first real generation in the history of the world to "retire." But what did retirement mean? It meant getting a gold watch and getting paid to sit at home. Unfortunately, it also most likely meant you were going to die soon thereafter.
Fortunately, for my grandfather he lived a long and healthy life. I would go to lunch with him and ask for his best advice. The most important and prescient advice that he gave me is that had he known how long he was going to live he would have had another career. The life expectancy of men in his time was about 65 years old. When he retired he didn't expect to live much longer. He was an actuary and knew the math. Retirement for his generation generally didn't last long.
His generation was really the first generation to use their brains and not dig ditches or push a plow. Manual labor was out so why the rush to retire? They were told that was what they were supposed to do. Retirement for our generation may include working longer than previous generations. The New Retirement, for those who are prepared, may be about having options.
Our generation will redefine what retirement is. Retirement is becoming the time in your life when you are the Master of your own destiny. You get to dictate the terms. In our mid-40s and 50s we are busy grinding it out every day and our families are counting on us. We put up with things that we may not enjoy or even hate. We do that because we can't afford to quit that job with the abhorrent boss or terrible pay. I have several clients who have been on the cusp of retirement over the last several years and when reaching their goal they have decided to keep working. Why? It has dawned on them that once they were in a position to retire - they no longer wanted to retire. Why would you want to quit? You are now at your most valuable. You have incredible work/life experience and the responsibilities of being at home are mostly gone. You can work more efficiently now and even mentor the next generation at work.
When we have saved enough money to "retire" we can wake up on a Tuesday and say no to that boss without fear. We can leap from that negative environment without another job in hand because we are prepared to take care of ourselves. What we are seeing now is men and women who have gained financial independence are continuing to work well after they need to. It is because they want to. It is because they can dictate the terms, some for the first time in their careers. The recipe is to work longer, dictate the terms and be your own Master. Make your retirement what you want it to be and on your terms. Studies tell us that those that are happiest and healthiest in retirement are those that have purpose, a strong community of friends and stay active. Let's face it. Most of us are not digging ditches for a living. We are using our brains. Why not work longer? What saving our pennies does for us in the new retirement is it gives us choices. The new retirement may be continuing to work while having the financial assets to do it at your pace, with whom, and where you find it most enjoyable.
The Current Quarter
No one said investing was easy but if you look at the numbers for Q1 you might think so. I had one client tell me that this was the best quarter he has ever had. We are glad to hear that. It was quite a quarter! This was the best quarter for World stocks since 2012. It was the best quarter for US stocks since 2009 and the best start to a year since 1998. Commodities were also flying as they are up 83% on an annualized basis. If they continue at this pace 2019 would be the best year for commodities since 1973, which, incidentally was the best year ever for commodities. If stocks continue their trajectory global equities will be up 67% by the end of the year. That would make for the best year since 1933, which, coincidentally, was the best year ever for stocks.
While the returns in Q1 were enjoyable we think that this has become one of the most difficult investing environments we have ever encountered. The yield curve has inverted and un-inverted, equity valuations are near all-time highs and we are 10 years into a bull market fueled by emergency monetary policies. There continue to be negative yields on over a trillion dollars' worth of government bonds around the globe and now we see that global growth is slowing. Global stocks and bond yields have decoupled and that, historically, has not been a harbinger of good things to come.
Why Such a Great Q1?
How the Fed Wimped Out
"It's 'pretty obvious' the Fed is moving to the whims of the markets."- Art Cashin NYSE Floor Operations UBS
Last fall the Federal Reserve seemed determined to remove excess monetary accommodation which had fed the rise in asset prices and wealth inequality. That is until December came and markets dropped 14%. As far back as 2014 we see from the Fed Minutes that Fed Chairman Jerome Powell was aware of the risk taking that the Fed had encouraged market participants to make and the moral hazard that it had created.
I think we are actually at a point of encouraging risk-taking, and that should give us pause. Investors really do understand now that we will be there to prevent serious losses. -Jay Powell FOMC Minutes 2014
In the fall of 2018 Mr. Powell seemed determined to extinguish some of that risk and continued with his withdrawal of monetary accommodation through rate hikes and balance sheet reduction and, as we expected, those withdrawals were a negative for asset prices and stock prices fell. What may be more important here is that the pace of the retreat in asset prices may have been the straw that broke Powell's back. He is faced with a boss who sees the level of the stock market as a barometer of his success. In that environment perhaps the political pressure was too much to bear and Powell backed off of his approach. The reality to us is that the swiftness of the fall in asset prices had more to do with the calendar than his approach. This is an important concept that I will only touch on. In today's market, volatility is tied to liquidity. In less liquid times of the market, volatility rises. The end of the calendar year is one of those times and it may have squelched Powell's grander plan.
So, from expectations for two to three more rate hikes in 2019 and a balance sheet reduction on auto pilot, Powell quickly made a U-turn and announced that the balance sheet reduction would be complete by the end of 2019. The market has also ascertained that there will be no rate hikes in 2019 and perhaps even a rate cut. Other central banks such as the Chinese central bank and the ECB quickly followed suit with their own liquidity measures. The liquidity spigot was back on and so was the race to buy assets.
The market is now stuck splitting the difference between being a late cycle market which is richly priced and one that is being enhanced by central bank liquidity. The market now knows that the Fed will have its back and, is again, in the business of encouraging risk taking. The Fed Put as it is called is now located right at the December lows and the whole of the investing world knows it. The Fed has shown its cards and its position has been exposed. Buy the Dip is back.
But what is important is that the Fed is not going to allow any further steep correction beyond that,
if it can, and Powell has already shown his hand in terms of where his "put" is… and it is at the December lows."
- David Rosenberg
Chief Economist & Strategist, Gluskin Sheff + Associates Inc.
You cannot fight the Fed is the old mantra and this is apparently still true - in either direction. When the Fed appeared to tighten markets fell. When they loosened the reins markets jumped faster than they fell. While we were correct in our assessment of the negative impact of a tighter Fed in late 2018 we have been taken by surprise by their quick flip flop and the markets' outstanding response due to the impact of a more dovish stance by the Fed. We don't think that we are alone. We foresaw that Wall Street was looking to rent this rally as buyers in late 2018 in the idea that the lows of December would need to be tested once again. Markets tend to fall in predictable cycles and that would be the template. The flip flop by the Fed has turned that strategy on its ear and most of the investing world was caught flat-footed or, at least, under-invested in equities.
It's Different this Time
"The reality is that maybe the word 'cycle' is no longer even relevant, given that we have so much unconventional central-bank involvement." - Dubravko Lakos-Bujas JP Morgan chief U.S. equity strategist
The most dangerous words in investing may be "It's different this time." History doesn't repeat but it does rhyme. We have a tendency to extrapolate what is current to what will happen in the future. It is called Recency Bias. Cycles exist in nature, in humans and in human nature - we tend to repeat the mistakes of the past. Every time the world has faced a new crisis since 2009 central banks have stepped in to solve the problem. So much so that the world's investors have become conditioned to expect their response which, in and of itself, levitates asset prices. After the Brexit vote in June of 2016 central bankers didn't even respond to the perceived crisis. Investors did their work for them. Investors, expecting the banks to chime in, elevated asset prices for them.
We have seen central banks try and elongate or eliminate cycles in the past and it has never worked for very long. At some point even that cycle ends. Cycles are still relevant, it is just that this central bank cycle may last longer than we think. In this rally, the latest of central bank's levitating acts, stock valuations here in the US have risen while earnings for US corporations are falling. Fundamentals do not seem to matter in light of dovish central bank policy. It's never different this time and at some point central bankers will fail in their resurrection of asset prices in the time of crisis.
As the first quarter comes to a close we see the S&P approaching its all-time highs last seen in October of 2018. In the last six months we have seen expectations and macro-economic data collapse. We have also seen the widely followed Economic Data Index from Citigroup (NYSE:C) fall to its lowest level since July of 2017 while semiconductors, a widely watched indicator of economic health, have reached all-time highs. This presents a bit of conundrum.
According to the sharp eyes of Michael Wilson at Morgan Stanley (NYSE:MS), more than 100% of this rally in 2019 is from multiple expansion - the excess amount investors are willing to pay for the same amount of earnings. At almost 17 times forward 12-month earnings per share (EPS), the S&P is trading at elevated valuations and those valuations are elevated not due to more earnings but due to higher expectations or the willingness to pay more money for the same dollar of earnings. In light of that, keep in mind that we expect this quarter to be the first negative year-over-year quarter for earnings since 2015/16.
Why are investors willing to pay more for earnings in light of the current environment? It could be because investors see a temporary slowdown in earnings and that a rebound in growth will occur over the latter half of 2019. While that rebound may happen we believe it is due to the recently reinvigorated dovish monetary policy. The markets seem to be completely reliant on dovish central bankers. Markets see any temporary earnings trough as being met with even more dovish monetary policy from around the globe. There is nothing to fear as central bankers have made it clear they will always come for the rescue.
The market seems to be hanging its hat on the idea that when the yield curve inverts the market heads higher for 9-18 months before the recession hits. Since 1966, the average gain one year after inversion is 8%. The sample size is too small to be significant but that isn't stopping the bulls. The canary in the coal mine may be when the curve begins to steepen - when the Fed cuts rates. The last three times the Federal Reserve cut rates the US was in recession within 3 months (h/t ZH). The average drawdown in a recession is 35%. Markets may continue to run higher as investors have a Fear of Missing out (FOMO) on further gains. It looks like everyone thinks they will just get out before everyone else. Those exits close quickly once the selling starts especially in the less liquid ETFs.
So where are we? Markets, to an extent, are dictating policy. The Federal Reserve is hamstrung by this and is now path-dependent. They are dependent on the path of asset prices. Stocks' values will move up to a critical level. Fed officials may then take the opportunity to become more hawkish and discuss raising rates and shrinking the balance sheet. Asset prices will begin to go lower as confidence declines and demand softens. Once the stock market reaches critical support levels you will then begin to see Fed officials out making speeches about how they are flexible in regards to the balance sheet/interest rates and that we have a strong economy and everything is fine. Assets will then, most likely, find their footing and begin to rise. Wash, rinse, repeat.
First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy.
I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what's happening because you thought through all the possibilities, - Lloyd Blankfein CEO of Goldman Sachs
Moreover, the years ahead will occasionally deliver major market declines - even panics - that will affect virtually all stocks…During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well. - Warren Buffett
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.