Returns for the major stock indices for 2019, and the current bond and money market yields are as follows:
|Dow Jones Industrial Average||15.28%|
|Fixed Income Yields||1 year||5 year||10 year||30 year|
|Fidelity Government Cash Reserves Money Market Fund||2.07%|
Happy 4th of July! As we celebrate the birth of our nation, we would like to reflect on the incredible first half of 2019 in the equity markets. We just recorded the best June in the stock market since 1955 and are up over 18% year to date. We again endured volatility as the month of May was down 6.35% alone for the S&P 500, reminding us that markets do not go straight up. By the end of June, the markets fully recovered all of May’s decline. Though we are never comfortable over-emphasizing short-term markets, we believe it is healthy to reflect on the values of resilience, discipline and the grinding faith that markets will ultimately appreciate over time for inherent reasons. We also take some solace knowing the U.S. equity markets have rallied back to new highs after every decline.
With the above optimism in mind, we are always concerned about the future and as is said repeatedly in this business: past performance is no guarantee of future results. We have written multiple times about our concerns for attractive fixed income options due to falling interest rates and rising bond prices (remember the inverse correlation: as bond prices rise, interest rates fall). In our third quarter 2017 letter, we noted that bond prices and their distortion from historical norms are the anomaly in the markets we discuss the most often and that we look forward to the day we can return to more conventional asset allocations.
While we do not know when bond prices will return back to the
mean, we believe it is worth discussing the thought processes of an investor
currently willing to purchase a medium to long-term government bond. As noted above, the 10-year Treasury yields 2.01%. To faithfully decide to invest in a
government bond today, you must be willing to commit money to a rate of return
less than the long-term inflation average of 2.9%; by definition you are losing
power annually. As contrasted with the equity markets, the S&P 500 dividend yield is 2.02%. In buying a 10-year bond, you are conceding (generally) that you do not believe the equity market will appreciate over the next ten years. And finally, at 2% bond yields, these investors are willing to pay an astoundingly high market multiple of 50 times earnings or 2.5 times the S&P 500 index.
At LYNCH & Associates we cannot reconcile such pessimism for the future. Textbook investing teaches us that stocks and bonds often have an inverse relationship; while one market is rising, the other is falling. Recently, this negative correlation has been off the table, as the performance in government bonds has stagnated. The conventional asset allocations of 50/50, 60/40, 70/30 equity to bond ratios are not currently the complement they once were. The bond market is simply not providing attractive opportunities domestically or abroad.
Many countries (France, Japan, Germany to name a few) currently have negative interest rates. Europe now has more than 10 trillion dollars in negative yielding bonds. Yes, investors are buying bonds that guarantee not only a negative real rate of return but also a negative nominal rate of return. Incredible! Paying for the guarantee of losing money. Point being, the bond market valuations are off the charts compared to other asset classes. For now, we believe it is more advantageous, in most situations, to preserve your fixed-income capital for another day. Money market rates are favorable enough, relatively speaking, to maintain your patience here with new capital in your fixed income allocations.
We have written about the acronym TINA (There Is No Alternative) and continue to feel there is currently no attractive alternative to equities. Although humility reminds us to be cautious, we remain optimistic on equities for many reasons despite an aging bull market and many late-cycle signals. Finally, while we may excessively caution our clients to expect on average one 10% decline per year, three 5% declines per year and a 20% decline every four years, it is also necessary to remember the market has produced a 30%+ positive year on average every fiveyears (which has not happened since 2013).
Thank you again for your continued confidence in LYNCH & Associates. We look forward to the opportunities and challenges ahead of us. As always, we welcome you to schedule an appointment to review your personal financial situation.
Ryan T. Lynch, CFP® ChFC®
Form ADV Part II of the LYNCH & Associates Uniform Application for Investment Advisor Registration and the LYNCH & Associates Code of Ethics are available to all clients at any time. If you would like to receive a copy, please contact Jennifer Farless at (812) 853-0878 or jfarless@LNAonline.com.
Office: 10644 Newburgh Road, Newburgh, IN 47630