Recent News

May Unemployment Looks Great

June 8, 2018 By Eric Ludwig

May Unemployment Looks Great

In over thirty years of watching the economy we’ve seen recessions, recoveries (both slow and fast), panics, lulls, and boomlets. But we’ve rarely seen a job market this strong.

Everything is hyper-politicized these days, and we get accused of playing politics all the time. But what we care about deeply, what drives our focus, is the growth that creates opportunities for individual skills to shine in service to others. The development of assets – both physical and intellectual – to build for the future. But it all starts with work, and there are now more Americans working than ever before – over 148 million, to be precise.

Nonfarm payrolls grew 223,000 in May and are up 2.4 million in the past year. Civilian employment, an alternative gauge of jobs that better measures small business start-ups, grew 293,000 in May and is up 2.3 million in the past year.

And, importantly, it’s the private sector driving growth, not government. Government jobs are up a total of 21,000 in the past year. Meanwhile, manufacturing payrolls are up 259,000 in the past year, the fastest twelve-month increase since 1998. If technology is supposed to be killing employment in manufacturing, I guess they didn’t get the memo.

No matter how you slice it, things look good.

But we’re not done. The unemployment rate dropped to 3.8% in May, tying the lowest reading since 1969. We think we’re headed lower, forecasting a 3.2% rate by the end of 2019 with a chance for a 2-handle on the unemployment rate sometime in 2020.

May also saw the black unemployment rate fall to 5.9%, the lowest reading since record keeping started in the early 1970s. Black employment is up 3.5% per year in the past two years, versus a 0.9% per year gain for whites. As a result, the gap between the black and white unemployment rates is now only 2.4 percentage points, the smallest gap on record.

Let’s keep it going. In the past twelve months, the average jobless rate among those without a high school degree is 6.0%, also the lowest on record (going back to the early 1990s).

Still, people bemoan wage growth. We’ve never thought average hourly earnings (which do not include irregular bonuses, commissions, or tips) are a good measure of living standards. “Real” (inflation-adjusted) average hourly earnings are up just 0.2% from a year ago and up 7.2% from the start of the last recession. But, again, this does not include the one-time bonuses many companies paid after the tax cut was enacted late last year.

In addition, there’s evidence that the Labor Department’s measure of wage growth is being held down by the retirement of older, more highly paid Baby Boomers, while new-hire Millennials are just beginning to climb the compensation ladder. So while average hourly earnings for all workers are up 2.7% (not adjusted for inflation), if you take out new entrants and retirees, wage gains are up 3.3% in the past year. We expect this to accelerate, pushing overall wages higher as well.

It’s a tight labor market, with initial claims at the lowest level ever as a percent of total employment and wages rising fast enough to pull people off the disability rolls and back into the job market.

This will help improve the low labor force participation rate. Participation among prime-age workers – those 25-54, who are either working or looking for work – was 81.8% in May, the same as the average for the past year.

To put that in perspective, that’s higher than it ever was before 1986. The averages by decade are 67.4% in the 1950s, 70.0% in the 1960s, 74.2% in the 1970s, 81.1% in the 1980s, 83.7% in the 1990s, and 83.1% in the first decade of the 21st Century. Even the all-time high for any twelve-month period, back in 1998-99, was 84.2%, not substantially higher than it is today.

So, while participation is down from when the U.S. population was younger on average, it’s way up compared to the 1950s-60s, which many view as a strong period for the labor market.

Back in the 1950s and 60s, redistribution of income was well below today’s levels. If the U.S. really wants more people in the labor force it must either reduce government benefits for not working or wait for the private sector to raise wages enough to pull people off government programs. With the recent strength in the labor market, the latter seems more probable. Tax cuts and deregulation will keep the job market strong.

Eric Ludwig is a Certified Financial Planner in Sun Prairie, WI primarily for a select group of successful professionals and business owners, who aspire to a work-optional lifestyle. Stockbridge has developed and refined a process to put all the pieces of the financial puzzle together and we call it the Stockbridge D3 Process, which stands for Discover, Design, Deploy.

Raise Rates 50 bps. Why Not?

May 21, 2018 By Eric Ludwig

Why Not 50?

Asking if the Federal Reserve will lift the federal funds rate on June 13 is like asking if Las Vegas Golden Knights goalie Marc-Andre Fleury, who has stopped 94.7% of the shots against him in the 2018 Stanley Cup playoffs, will stop the next one. It’s a virtual lock.

And everyone knows the rate hike is almost guaranteed to be the very same 25 basis point (bp) increment the Fed has used six times in the current rate hiking cycle, starting in December 2015. In fact, that’s the same 25 bp increment the Fed used consistently between June 2004 and June 2006, totaling seventeen drip-drip-drip rate hikes in all. That campaign lifted rate 425 bps total, every one of which was telegraphed. Rates moved from a starting point of 1% to a peak of 5.25%.

We need to go all the way back to May 2000 to find a meeting at which the Fed raised rates by 50 bps – the final rate hike of that cycle – after a series of 25 bp hikes that started in mid-1999. In other words, the Fed has become comfortable and predictable with 25 bp moves, which seems to be all about not getting blamed for any kind of short-term market turmoil.

So why not raise by 50 bps?

Everyone knows the Fed will lift rates by at least another 50 bps this cycle. The federal funds futures market puts the odds of the Fed raising rates by less than 50 bps this year at 6.6%. We’re sure the odds would be even lower if we included 2019. That’s as close to a sure thing a Marc-Andre Fleury.

So, if the Fed is going there anyhow, why not get there sooner? Why not get to a neutral monetary policy more quickly? Why be so predictable?

Raising rates by 50 bps this early in the cycle isn’t going to make monetary policy tight. Right now, nominal GDP (real GDP growth plus inflation) is up 4.8% in the past year and up at a 4.4% annual rate in the past two years, well above the current federal funds target of 1.625%. The 10-year Treasury yield is about 145 bps above the funds rate. Meanwhile, the banking system is chock full of excess reserves and a record amount of capital. Congress and executive agencies are moving to undo some of the excess regulations on the banking system, there are no major bubbles in the financial system, and corporate balance sheets are in fantastic shape.

Add in an unemployment rate of 3.9%, well below the Fed’s consensus view that its long-term average will be 4.5%. Plus, the PCE deflator, the Fed’s favorite inflation measure, is already up 2% from a year ago and, given the recent rise in oil prices, should hover persistently above 2% for the rest of the year.

One of the key problems with “forward guidance” and gradually lifting interest rates on a predictable schedule is that it’s too predictable. It’s like clockwork. At present, everyone thinks they can predict the movement of future short-term rates with little to no risk. Which is exactly what happened in the previous decade. By telegraphing every move, the financial system could use simple spreadsheets to build a strategy for taking advantage of 25 bp moves at every meeting. This led to a complacency and a willingness by many players to take on excessive risk. In many ways, this is the same thing President Trump complained about with our military – always telling the world exactly what we would do and when we would do it.

To be precise, we’d like to see the Fed raise rates by 50 bps in June. Then, using its dot plot and press conference, the Fed could signal more rate hikes to come while also, by going 50 bps at this meeting, signal that timing is always on the table. In other words, the Fed would probably raise rates by a total of 100 bp this year, but the average level of short-term rates in 2018 would be slightly higher than if it moved only 25 bps at a time. This would move long-term rates higher sooner as well.

Surprising the market would not be the end of the world. Back in September, the Bank of Canada surprised with a rate hike and lived to tell the tale. Canadian equities are up since then. And the Canadian dollar is up, as well.

Once again: we’re not holding our breath waiting for the Fed to surprise the market. The most likely outcome on June 13 is yet another 25 bp rate hike. But if the Fed really wants to prevent the kinds of imbalances that built up before the last recession, it should consider introducing some upside uncertainty into the path of short term rates.

Eric Ludwig is a certified financial planner in Madison, WI primarily for a select group of successful professionals and business owners, who among other things aspire to a work-optional lifestyle. Stockbridge has developed and refined a process to put all the pieces of that puzzle together and we call it the Stockbridge GPS process. GPS stands for Goals, Planning, Strategy.

Labor Market Strength

May 14, 2018 By Eric Ludwig

Labor Market Strength

The US labor market has rarely been stronger.

Recent figures from the Labor Department show US businesses had a total of 6.550 million job openings in March versus 6.585 million people who were unemployed. That’s a gap of only 35,000 workers. By contrast, this gap never fell below 2 million in the previous economic expansion that ended in 2007, and stood at 638,000 in January 2001, at the end of the expansion that started in mid-1991 and ran through early 2001.

Of course, these figures have to be put in context. The measure of unemployed workers doesn’t include “discouraged” workers, for example, nor does it include part-time workers who say they want full-time jobs. And it’s not like all the unemployed have the skill sets needed for the job openings that are available.

Still, the negligible gap between the number of job openings and the number of unemployed who are pursuing work shows that the demand for labor is intense.

Reports on jobless claims show companies are clinging to their workers. In the past four weeks, the average pace of initial jobless claims has been the lowest since 1969; meanwhile, continuing claims have averaged the lowest since 1973.

And new jobs continue to be created. In the past year, nonfarm payrolls are up an average of 190,000 per month, matching the pace of the year ending in April 2017. As a result of this continued job creation, the jobless rate has dropped to 3.9% in April, the lowest since the peak of the internet boom in 2000.

Assuming a real GDP growth rate of 3.0% this year and next, we think the jobless rate will finish 2018 at 3.7%. That would be the lowest rate since 1969.

Then, in 2019, the jobless rate should drop to 3.2%, the lowest since 1953. Beyond that, continued solid growth could realistically push the jobless rate below 3.0%.

Maybe it’s optimism about the labor market that’s behind President Trump’s recent tick upwards in popularity and the GOP’s better performance in the “generic” ballot, which measures whether potential voters are inclined to support Republicans or Democrats in House races this November. Either way, it doesn’t seem like an environment that favors a tidal wave of change for the Democrats this fall. The odds of the GOP keeping the House are rising, and the GOP looks more likely to gain Senate seats than lose them.

Although some still bemoan slow growth in wages, April average hourly earnings were up a respectable 2.6% in the past year. And that doesn’t include the kinds of one-time bonuses that have become more widespread since the tax cut was enacted in late 2017.

The biggest blemish on the labor market is that the participation rate – the share of adults who are either working or actively looking for work – is still low by the standards of the last forty years. After peaking at 67.3% in early 2000, the participation rate has declined to the current reading of 62.8% in April.

This drop is mainly due to three factors: the aging of the Baby Boom generation into retirement years, overly generous student aid (which has reduced the willingness of young Americans to work), and disability benefits that are too easily available. Hopefully, the coming years will see policymakers find ways to tighten rules on disability while limiting student aid to truly needy students who are taking economically useful coursework.

But even if these changes don’t happen, look for more good news – and an even stronger labor market – in the year ahead.

Are you suffering from Market Anxiety?

January 20, 2016 By Eric Ludwig

In this episode of the “Money on my Mind” show, we discuss anxiety about the market.

Despite what’s going on in the Oil Market, or China, or what the talking-heads on CNBC are saying, or what some pessimistic analyst writes, let’s find out if we really should be worried. Enjoy!

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There’s no diplomatic way to say this: the global stock markets are supremely volatile right now. Going forward, it’s hard not to be worried about predictions like the one from Royal Bank of Scotland analyst Andrew Roberts, who says the global markets “look similar to 2008.” Roberts also predicts technology and automation are set to wipe out half of all jobs in the developed world. If you listen closely out the window, you might almost hear traders shouting “Sell! Head for the exits!”

When you’re in the middle of so much panic, when people are stampeding in all directions, it’s hard to realize that there is no actual fire in the theater. Yes, oil prices are down dramatically, and could go lower, which is not exactly terrific news for oil companies and oil services concerns — particularly those who have invested in fracking production.

But cheaper energy is good news for manufacturers and consumers, which is sometimes forgotten in the gloomy forecasts. Chinese stocks and the Chinese economy are showing more signs of weakness, and there are legitimate concerns about the status of junk bonds. These bonds have stabilized in the past few weeks, but another Fed rate hike could destabilize them all over again, leading to forced selling and investors taking losses in the dicier corners of the credit markets.

If you can think above the shouting and jostling toward the exits, you might take a moment to wonder about some of these panic triggers. Are oil prices going to continue going down forever, or are they near a logical bottom? Is this a time to be selling stocks or, with prices this low, a better time to be buying? Are China’s recent struggles relevant to the health of your portfolio and the value of the stocks you own?

And what about Roberts, who’s essentially yelling “Fire!” in the crowded theater? A closer look at his track record shows that he has been predicting disaster, with some regularity, for the past six years — rather incorrectly, as it turns out. In June 2010, when the markets were about to embark on a remarkable five-year boom, he wrote: “We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe) and for the global economy. Think the unthinkable,” he added, ominously. (“The unthinkable,” whatever that meant, never happened.)

In July 2012, Roberts wrote: “People talk about recovery, but to me we are in a much worse shape than the Great Depression.” Wow! Wasn’t it scary to have lived through, well, a 3.2% economic growth rate in the U.S. the following year? What Great Depression was he talking about? Taking his advice would have put you on the sidelines for some of the nicest gains in recent stock market history. It’s also interesting to note that Roberts did not predict the 2008 market meltdown.

Since 1950, the U.S. markets have experienced a decline of between 5% and 10% (the territory we’re in already) in 35.5% of all calendar years — which is another way of saying that this recent downturn is entirely normal. One in five years (22.6%) have experienced downturns of 10% to 15%, and nearly 18% of the last 56 years have seen downturns, at some point in the year, of more than 20%.

Stocks periodically go on sale because people panic and sell them at just about any price they can get in their rush to the exits, and we are clearly experiencing one of those periods now. Whether this will be one of those 5%-10% years or a 20% year, only time will tell. But it’s worth noting that, in the past, every one of those downturns eventually ended with an even greater upturn and markets testing new record highs.

In times like these it is helpful to remember that, in order to generate the type of long-term returns that create wealth, you have to accept a certain amount of risk. With that risk comes volatility. The key is not to take steps to avoid the risk altogether, but to manage the risk where possible.

Here are 4 important things to consider:

Diversify– Diversification is your best friend in volatile markets.

Allocation– Percentage exposed to stocks versus bonds can help reduce the volatility of the market and increase wealth over time.

Rebalance – A recent study by Vanguard notes that rebalancing at 5% thresholds is the optimum balance between risk control and cost minimization.

Evaluate – What stage in life are you in? Do you need income, growth or preservation of principal, and what is your ability to take risk in the market and stay in for the long run?

As a final note, David Booth from Dimensional Fund Advisors observed, “Where people get killed is getting in and out of investments. They get halfway into something, lose confidence and then try something else. It’s important to have a philosophy.”

Are you exactly on track with your financial plan?

December 16, 2015 By Eric Ludwig

When NASA launches a spacecraft to land on the moon (yes, I know that’s been awhile) what percent of the time does it spend on its intended path?

It’s only 3% of the time. The Apollo missions took about 3 days to reach the moon. This means that out of the 3 days to reach the moon, they were on their intended path for only about 2 hours! That’s it! What the heck does that have to do with investing? I think it’s a worthwhile analogy.

As humans, we set goals, whether it’s going to the moon, buying a house, saving for college or being independently wealthy. Goals are so important because it guides our actions and it gets us moving in the right direction. Apollo was only on its exact intended path 3% of the time, but its trajectory, it’s path, was always moving closer to the moon. (if you’re a bad golfer like me, you know the feeling)

And so is the case with financial goals. When we run a projection for a financial plan that earns 6% per year, that does not mean we will earn 0.0238% per day. Investing doesn’t work that way. Sure, there will be some days that we earn exactly 0.0238% in one day, but I have a feeling that occurs even less often than Apollo was on track towards the moon. It’s more likely that we have days like today: the Fed raises rates, your portfolio jumps 1.28% today. Tomorrow it goes down a little, and on and on.

But daily returns don’t matter. Frankly, monthly, quarterly, and semi-annual returns aren’t the most important thing either. Those are just results. That’s the scoreboard. What matters is that we’re taking the right actions towards our goals, and making course corrections along the way. That’s even how our investment models work: making adjustments as we adapt to changes in the global markets. We will experience down days, months and quarters along the way. As investors, we shouldn’t be surprised by that, we should expect that. That’s how investing works. Volatility is just part of the process. If your account didn’t fluctuate, you’re either one of Bernie Madoff’s clients or sitting in cash.

That’s why focusing on process is so important (vs results). Goals change as we have new experiences. The goals we had when we were 5 changed by the time we were 15, and changed when we were 25 as we had new experiences along the way. But at least goals put us on the right trajectory towards the things that are most important to us in life. A cool exercise: think about a goal and then ask yourself “if I accomplish that goal, what will that mean to me.” For example, goal: have a million dollars. What will that mean? I’m rich. What will that mean? I don’t have to work anymore. Why is that important? I can spend more time with my family, exercise, and hiking. Ahhhhhh….now we’re on to something.

General advice: Think big. As someone once said “aim for the moon. Even if you miss, you’ll still land among the stars” …even if we’re off track 97% of the time.

Do you have an investment strategy or are you gambling?

December 11, 2015 By Eric Ludwig

Do you have an investment strategy, or are you gambling?

Recently, somebody asked for my opinion of a certain stock they were considering buying. I never know quite how to answer that question because buying individual stocks isn’t part of the investment strategies we run. For 1, I’m not a big fan of owning individual stocks because I’d much rather own a commission-free, low-cost ETF that consists of 1,000 companies instead of buying only 1 company. And 2, it probably doesn’t matter so much as “what stock to buy” as much as it does to be able to answer “when should I buy it” and “when should I sell it.”

The reason this question irks me so much though, is because it gets at the root of most investors problem: they’re gambling, not investing. How do you know if you’re a gambler or an investor? The ex-airline pilot in me has created a checklist to find out. If you answer “no” to any of the questions, you’re probably just gambling with your money. Or even worse, if you use the services of an investment advisor and they answer “no” to any of the questions, you’re paying someone else to gamble with your money…not cool dude!

First, the nuts and bolts of what makes it an actual strategy:

My investing decisions can be boiled down to rules that could be programmed into a computer and answer the following:
1. what to buy
2. when to buy it
3. how much to buy
4. what to sell
5. when to sell it
6. how much to sell

Now you see why asking me “what do you think of this stock” just seems odd to me. If it fits your investment strategy’s rules, buy the stock; if not, don’t buy it. It’s pretty linear thinking at this level. The idea of some stock jockey sitting in front of 15 computer screens watching their indicators with beads of sweat dripping down their forehead is Hollywood my friend, not Wall Street. Investing, pragmatic investing, is pretty damn boring. You run your system, you follow the rules, you go on about your day. Once the rules are developed, it’s all about the proper execution of the strategy and just following the rules. Think about weight loss for example. You eat healthy, eat less, you exercise. You just follow the steps and the results will happen. That’s why it’s so important to focus on “process”, not “outcome.” You can’t change the outcome. That just happens. But we can change our process. And a better process will eventually lead to better results.

The next part of the checklist will determine if the strategy will actually make money or not. For example, I could come up with a “strategy” that buys all stocks that start with the letter A, every January, with 100% of my account value, and then sell them in December and repeat with the letter B next January. That fits all the criteria to make it a “strategy”, but now we need to address whether or not it will make money. And last time I checked that is the point of investing, right. We need to be able to answer ‘yes’ to these questions:

My investment strategy is based on a market truth of how the market really works (ex. momentum, short-term mean-reversion, trend-following, etc. Not “buy in May and go away”.)
My investment strategy has a repeatable edge that is not sensitive to input metrics, as determined by robust back-testing results (okay, that was the nerdiest thing I wrote today, but it’s very important. Many back-tested systems work because someone tried 487 combination of inputs until they finally got 1 that showed it would generate $200 million in 5 years. If you roll the dice long enough, you’ll eventually roll a pair of snake-eyes 10 times in a row. But we want positive results that work under all market conditions. That’s what I mean by being robust, and not chance.)
I can calculate the expected return, maximum equity drawdown, and probability of a positive and negative year (again, the only way to know this is because you can back-test a set of rules that you created in step 1 above)
Finally, once you know the risk and return metrics, does the strategy fit your goals? Does it fit your comfort level? The reason Kahnemann won the Noble Prize in economics for doing research on behavior, is because he knew that at the end of the day, it is investor behavior that has the biggest outcome on our final wealth result, not investment performance. Do you buy at market peaks and sell at market bottoms? Do you exit because you’re currently down 6% even though historically the strategy has been down 10%? Those decisions will have a much larger impact on our final wealth result than anything else in the checklist. Since 1980, even Warren Buffett has had 4 times of losses worse than 30%, and 2 of those losses were worse than 50%! On the upside, he’s outpaced the stock market (that’s investment performance). But how many people can sit through 30% drops, or 50% drops, especially in retirement? That gets to the core of investor behavior. See what I mean?

If you have a portfolio of actively managed mutual funds with internal costs of 1% per year, plus a 1% management fee that’s re-balanced quarterly (like they do at companies that rhyme with “you, “es”, pank”) you have a strategy, it’s just not a very good one, unless you actually like paying high fees and can sit through 50% losses every 8 years. Or, if you buy Disney stock because Star Wars is coming out next week, I’m sorry fellow nerdy friend, but that’s more gambling than investing. Spend your money going to the movie instead! You could even ask a girl to go with you!

Final point: having a pragmatic set of rules to follow for making investment decisions, that will get you closer to your unique financial goals, is where we should focus our time. And in the final analysis, that’s all that really matters. If you want to know “whaddya think of XYZ stock?” call Jim Cramer instead of me. At least he’s entertaining.