Monthly Recap

Another busy month of data and dram with the markets dropping and trade war escalating. To recap, here are just some of the noteworthy events and stories from May:

President Trump increased tariffs on Chinese goods to 25% which caught the markets off guard. China responded with their own set of tariffs on around $60B worth of US goods. This continued escalation adds uncertainty at a fragile time in the economy and will surely knock some growth off GDP. Beijing’s threat to use its dominance of rare earths in the trade war risks serious disruption to U.S. industry, by starving manufacturers of components commonplace in everything from cars to dishwashers and military equipment
With the trade wars front and center, the S&P 500 has formally delivered its worst May return in seven years and second-worst since the 1960s, falling 6.6%. For tech traders watching the Nasdaq 100, the experience was only a shade less harrowing than the crash months of October and December.
An emotional Theresa May announced she will quit as Britain’s prime minister after admitting she had failed to deliver the one task that defined her time in office — taking the country out of the European Union. May said Britain now needs a new prime minister to take over and try to complete the task that has defeated her. She will stand down as Conservative Party leader on June 7, with a leadership contest formally beginning the following week.
Uber’s long awaited IPO came with a thud. The shares were priced at $45 and closed at below $42 on opening day. In the days following, the shares traded under $37 and at the time of my writing are still at around $42 and below the IPO price. Uber highlights the risks of going to the IPO too late. However, it’s early investors were handsomely rewarded with massive returns.
With the markets falling alongside trade war fears, the US yield curve once again inverted with the yield for 3 month T-bills being higher than 10 year treasury bonds. An inverted curve has been a harbinger for a recession in the past.
Special Counsel Robert Mueller said Wednesday that he couldn’t reach a conclusion on whether Donald Trump obstructed justice, as he stopped short of delivering a full exoneration of the president. He defended his investigation, as he announced that he was closing his office and stepping down.
The Federal Reserve identified rising sales of risky corporate debt as a top vulnerability facing the U.S. financial system. Officials for the second time in six months cited potential risks tied to non-financial corporate borrowing, particularly leveraged loans—a $1.1 trillion market that the Fed said grew by 20% last year amid declining credit standards. They also flagged possible concerns in elevated asset prices and historically high debt owned by U.S. businesses.

My 2 Cents

This My 2 Cents is quick and relates to public pension funds. Overall, the American Legislative Exchange Council estimates that pension plans have only about a third of the funds on hand—33.7 percent—that they need to pay promised benefits. Some states have significantly lower funding levels, which means they are at risk of running out of funds in the near future. Once a state or local pension plan runs out of money, taxpayers have to fund the pension benefits of retirees as well as the contributions of current employees. Connecticut, Kentucky, and Illinois have the lowest funding ratios, at 20 percent, 21 percent, and 23 percent respectively. Already, Illinois spends as much on pensions as it does on welfare and public protection (that is, police and firefighters) combined, and nearly half of its education appropriations go toward teacher pensions. If the state’s pension plans reach insolvency, pensions could become its single biggest cost.

Underfunded pensions are a huge problem and there’s been a lot of research written about them over the past several years as problems are arising. According to the American Legislative Exchange Council (ALEC), which uses more appropriate assumptions on investment returns than the plans use themselves—state and local governments’ unfunded liabilities now exceed $6 trillion. That’s a whopping $18,676 for every man, woman, and child, or nearly $50,000 for every household in America. That’s just an average and the reality is it will depend on which state and city you reside. You could (and likely would) see a mass exodus from certain states (such as Illinois) if they tried to collect these funds through increase taxes and levies. Taxpayers in Alaska, Connecticut, Ohio, Illinois, and New Mexico face the highest unfunded pension liabilities, ranging from about $28,100 to $45,700 per person.

Charts & Commentary

(In no particular order)

The amount of negative-yielding government bonds outstanding through 2049 has risen 20% this year to about $10 trillion, the highest level since 2016, according to data from Deutsche Bank Securities. The expanding pool of such bonds—which guarantee that a buyer will receive less in repayment and periodic interest than the buyer paid—highlights how expectations for growth in much of the developed world have deteriorated.

Just another example of bond yields that don’t make sense. Portugal is making the US look like a high yield bond.

Spain 10-year bond #yield, now at 0.85%, falls to the lowest level on record.

The PMI signals further near-stalling of global manufacturing at the start of Q2

Companies defaulted on 39.2 billion yuan ($5.8 billion) of domestic bonds in the first four months of the year, some 3.4 times the total for the same period of 2018, according to data compiled by Bloomberg. The pace is also more than triple that of 2016, when defaults were more concentrated in the first half of the year, unlike 2018. The trend is clear: unless something changes, 2019 will be the new high.

Uncalled commitments to private equity and venture capital funds continues to hit records. This could keep the M&A market strong for years to come.

The Fed’s recession probability meter is increasing. There’s a very correlation to a future recession when the level has been this high in the past.

Not a surprise that the markets are pricing in an interest rate cut before the end of the year.

The yield curve is moving further into negative territory as the trade war heats up.

GDP and PMI tend to be correlated. Not a surprise with everything going on that GDP estimates for Q2 are falling. JP Morgan just lowered their Q2 GDP forecast to 1%.

Here is a series of charts from Gluskin Sheff + Associates which speak for themselves:

Corporations have borrowed money to buy back stock at an incredible rate

We’ve had very high returns considering how low nominal and real GDP have been. This in turn has made the market very expensive.

I hope you enjoyed this months financial markets update. If you have any questions please contact us directly. If you’re interested in a topic that you’d like us to address, please email us so we can include them in future updates.

If you’re interested in starting a dialogue and learning how we can help, please contact us.

Best Regards,

Jared Toren
CEO & Founder

Sources: Edges & Odds, WSJ Daily Shot, 361 Capital, Steve Blumenthal’s On My Radar

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Author: Jared Toren

Jared Toren is CEO and Founder at Proper Wealth Management. Proper was born out of frustration with the inherent conflicts of interest at big brokerage firms influencing advisors to sell products that were not suitable for clients but profitable to the firm along with a consistently mixed message of who’s interest was supposed to be put first; the clients’, the firms’, shareholders or advisors. At Proper, our clients interests come first. We are compensated the same regardless of which investments we utilize so there’s no incentive for us to sell high commission products. Since we focus on a small number of clients, we are able to truly tailor our advice to each person’s unique circumstances.