Half-Time 2019: Off to a Good Start, but What's Next?

By Reby Advisors, July 19, 2019

Can you believe we have already passed the half-way point in 2019? If you think back, 10 years ago, the United States was emerging from the Great Recession. The Standard & Poor’s 500 Index was trading in the 900s in June 2009. Ten years later, in June 2019, the index is trading at three times that value!

Bob Reby, CFP®, recently sat down with Liz Ann Sonders, Senior Vice President and Chief Investment Strategist at Charles Schwab, for a “Fireside Chat” to discuss what it means to be in Year 10 of the longest economic expansion in U.S. history, whether a recession is on the horizon and how the current geopolitical landscape may impact markets.

Below are a few highlights from the chat. If you’d like additional analysis on what may happen in markets for the rest of 2019, register for our upcoming Half-Time 2019 Webinar.

Bob Reby, CFP®: If interest rates continue to go down, and we go into a recession, what's the Fed’s plan to help us out of the recession?

Liz Ann Sonders: The big question right now is, does the Fed have enough ammunition that they've built back up to combat the next move down in the economy? There's sort of good news and bad news parts of the answer. Rates went from zero up to two and a half percent right now, that's the Fed funds rate, the short rate that the Fed controls, so given that they typically make moves in 25-basis-point increments, yes, there's still a decent amount of room between where they are now and zero.

The negative thing from my personal perspective is hearing more Fed members, not yet Jerome Powell but many others, Bullard and Clarita basically say, "Look, negative interest rates are on the table." Which, I find very jarring because they don't work.

Reby: What is keeping inflation in check right now, despite higher wages and lower unemployment? What could cause inflation to actually start accelerating?

Sonders: The whole topic of inflation is an interesting one, especially in this cycle, this ten-year cycle. When we had the financial crisis, the Fed took interest rates to 0% and implemented quantitative easing.

People just assume, with the Fed printing all this money, Econ 101, this is going to be a massive inflation problem. We did not have that view, because what was missing in that analysis was, yes, the Fed was printing all of this money, which means that they were just piling reserves into the financial system, but the only way that would have become an inflation problem is if that money was coming out of financial institutions through the lending channels into the economy.

There's something called the velocity of money, that measures money coming out through the lending channels and picking up velocity.

Put simply: I go to a bank, I borrow $10,000. Assuming I don't go home and stuff it under my mattress, I take that $10,000 and I buy something, I build something, or I invest in something. The recipient of that now has $10,000. That's velocity. It's money moving through the economy. That's what tends to cause inflation.

If you don't have any velocity of money, you mathematically can't develop an inflation problem. Plus, you've had these secular forces on inflation, globalization and innovation.

Now I think the question to be asked is, "Could we be starting to lay the groundwork for maybe a bit more inflation?"

One, the velocity of money is starting to pick back up. Tariffs are inherently inflationary, especially if the next round of tariffs kick in. Even Wal-Mart came out last week and said, "we're going to pass this on to the consumer."

By the way, tariffs on Chinese goods are not paid by China. This is not a political statement. This is simply a statement of fact. Tariffs are paid by U.S. companies importing goods from China. And that tariff, which is a tax, is remitted to the U.S. Customs and Border Agency, which is ultimately remitted to treasury. So it's U.S. companies that pay the tariffs.

The next round of tariffs that kick in go right to consumer goods, to a much more significant degree than the prior tariffs. And if Wal-Mart is some semblance of a proxy, which I would argue is a pretty good proxy for consumer goods and retail, this is going to start to impact the consumer more. And if you see prices go up, it's not inflation in a traditional sense. It's more of a one-time tax, but you'll see it in the inflation numbers.

Audience Question: What do you do in today's environment to protect your capital?

Sonders: From an equity exposure perspective, which is one of the riskier asset classes, don't be any more exposed to stocks than your normal long-term allocation. And that's going to vary depending on the investor. Don’t get out over your skis and take on more risk than your financial plan calls for. On the fixed income side, focus on quality and don't chase yield by going into the risky areas like high yield or some of the lower-quality fixed-income.

Audience Question: With this environment and the tariffs, is it a good strategy to invest in stocks that have high dividends?

Sonders: One of the traps that investors can sometimes fall into, is chasing the classic yield areas, like utility stocks and telecom stocks. There can be such a frenzy to buy those stocks that it drives up the prices. So, even though they may have a high stated dividend yield, they may have horrible valuation. Sometimes, you get the dividend yield, but you pay the price by a massive correction in the prices of the stocks. So, just be mindful that oftentimes a dividend yield will be high because the underlying fundamentals of the company are incredibly weak.

So, you need balance between looking for reasonable yield, but also strong underlying fundamentals in the company. And if you're just purely kind of screening for high dividend yield, more often than not, that's a trap, because the yield is high because the fundamentals of the company are weak. In that case, the only way weak companies can attract assets is by offering a higher dividend yield. So, a blend of great company fundamentals and a better-than-average yield, absolutely, I think is a valuable strategy right now. Just don't put blinders on in the search for yield, because you'll end up getting burned at the end of the holding period.