With Labor Day now in the rearview mirror, most schools are back in session, and fall weather is going to be very welcome in many parts of the U.S.

It has been a brutally hot summer in several regions, including my home base in Connecticut. Sunday’s heat index here was 97 degrees and Monday’s was also about 100. Officials at the U.S. Open Tennis Championships in New York City have had to implement an unprecedented Extreme Heat Policy this year to help protect the tournament’s players.

But looking forward, cooler temperatures will inevitably be on the way, along with the gorgeous fall foliage here in New England. They both cannot come soon enough for my liking.

With September’s arrival, articles in the business press have started to trickle out on the 10th anniversary of the Great Recession. September 2008 might not have technically been its beginning, but a look back at an article from The Wall Street Journal from October 2008 indicates that economic data from that month were a harbinger of what was to come:

“Fears of a deep recession sparked the worst drop in the Dow Jones Industrial Average in 21 years, as retail sales tumbled, demand for commodities sank and bank earnings fell. … U.S. retail sales dropped 1.2% during September, the sharpest drop in three years. WSJ’s Sudeep Reddy says the decline signals the economy is already in recession and that it is facing a much deeper hit from the credit sector turmoil.”

What a difference a decade makes!

Whether one is inclined to fully credit the Trump administration’s actions or see this late-cycle recovery as the inevitable result of prior policies, there is no denying that many aspects of recent economic data have been impressive:

  • July 2018 retail sales topped estimates with a 0.5% monthly increase versus a year ago, and the trend line continues in a positive direction for the year.

Retail Sales

  • Consumer spending rose 0.4% in July, which was at the top of the estimated range.
  • While the University of Michigan’s consumer sentiment reading has faded slightly from the first quarter (at 96.2 for August), it is still in very healthy territory and above consensus expectations. The Conference Board reported last week that in its survey, “Consumer confidence increased to its highest level since October 2000 (Index, 135.8), following a modest improvement in July.”
  • Jobless claims continue to trend lower, and the overall unemployment rate stands at 3.9%.

New Jobless Claims

  • According to National Federation of Independent Business (NFIB), the Small Business Optimism Index rose by 0.7 points in July to 107.9, the second-highest level in the survey’s 45-year history and within 0.1 points of the July 1983 record high.
  • Leading economic indicators published by The Conference Board were at the top of the expected range for July. Said Barron’s, “This strength offers a favorable indication for the second-half economy.”
  • Kiplinger notes in its business investment forecast for the rest of the year, “A 7% pickup in business spending will be moderate by historical terms but will top last year’s 5.3% gain, showing strength in the nation’s industrial sector.” The wild card here is the impact of the continuing tariff/trade wars, which could resolve quite positively or resoundingly negatively.
  • The latest look at GDP growth for the second quarter also came in at the top of the range at 4.2% and has been trending higher on an annualized basis since early 2016.

U.S. GDP Growth

  • In the Federal Reserve’s minutes from their July 31–August 1, 2018 meeting, they said, in part, “labor market conditions continued to strengthen in recent months and … real gross domestic product (GDP) rose at a strong rate in the first half of the year.”

Not all is perfect, of course, and some important economic indicators and reports have had uneven performance this year. Wage and productivity growth continue to disappoint most analysts, the auto industry has been seeing a global slowdown in new vehicle sales, and the U.S. housing market has been inconsistent. Perhaps most troubling, consumer debt is at all-time highs, according to American Banker, and “the personal savings rate dropped to 2.4%, its lowest level since the debt-fueled boom of the mid-2000s.”

Additionally, questions abound from many corners on whether recent economic growth is a function of short-term impacts from the tax cuts, business-friendly deregulation, and the continuation of historically low interest rates this late in the business cycle—all factors which may not be duplicated going forward. Barron’s noted this weekend, “The Economic Cycle Research Institute’s array of indicators point to a ‘stealth cyclical slowdown.’”

That said, U.S. equity markets, which common wisdom asserts reflect the outlook for the next six months or longer, seemingly have voted positively on the intermediate term through the end of last week. Major U.S. equity indexes are near all-time highs again, a function of both the broad economic outlook and the strength in U.S. corporate earnings.

S&P 500 Last 12 months

Many articles in this space recently have focused on the wisdom of investors employing dynamically risk-managed strategies as they seek growth in their portfolios.

Why is this so important—even as the U.S. economy seems to be encountering a “green light” in so many areas?

Last week, we explored the “sequence of returns” as one important reason.

Another powerful reason is that no matter how rosy things seem now, history tells us that the next recession and equity bear market is inevitable. It would seem not to be a question of if, but when.

Jason Zweig, an excellent columnist for The Wall Street Journal, wrote recently on behavioral economics and the lessons it holds for all investors. Two of his very good points follow:

“Most investors tend to be unrealistically optimistic, overestimating how likely they are to have good fortune and underestimating how many bad things will happen. …”

“Behavioral economists say you should inform your decisions with the base rate, or the best available historical evidence of how likely an outcome is.”

According to data from Yardeni Research, every decade since 1920, with the exception of the 1990s, has had at least one market decline over 20%. Most of those declines were much worse.

Market Declines by decade

I sincerely hope that the end of this decade and the years that follow will prove to be as benign as the 1990s. However, it seems to make eminent sense to heed the advice from Mr. Zweig—advice that is often written about here—on being mindful of market history. Investors should seek equity growth in good times but employ portfolio strategies capable of mitigating market risk—reacting appropriately when those green lights again turn red.

(Note: The inconvenience of a heat wave is surely minor compared to some of the weather-related issues faced elsewhere in the U.S. this summer and happening right now. Our support and best wishes go out to all those affected.)

FPI Research update

The major U.S. indexes posted new highs this week. This is largely due to a continuation of positive economic news and reports. Recently released GDP numbers were in line with expectations, with significant growth of 4.2% year over year in the second quarter. This is due to a combination of factors, not least of which is the recently revised tax code. An additional tailwind was that the current administration may have reached an economic agreement with Mexico, which will lead to an end to significant tariffs imposed on the country earlier this year.

In markets such as these, where fundamentals are solid and bull markets are expected to continue (at least for the intermediate term), trend-following strategies tend to perform well. This is in contrast to range-bound markets where mean-reverting or seasonal strategies tend to perform better.

Core strategies such as our Lifetime Evolution and Dynamic Fund Profiles are poised to take advantage of markets such as these.

Lifetime Evolution is based on our proprietary Evolution methodology. This methodology rotates into the best-performing asset classes, while also positioning portfolio weights to reduce portfolio volatility and maximize portfolio diversification. The methodology seeks smoother investor returns along with higher-than-market returns. Lifetime Evolution does well in bull markets, but also provides safety in bear markets by being able to move to 100% cash or income securities in times of market turmoil.

Dynamic Fund Profiles creates a portfolio from all six of our Quantified Funds, using a resampled mean-variance optimizer: In short, it creates a robust allocation of our funds designed to maximize return for a given level of risk. Our Quantified Funds are largely run by trend-following or momentum-based methods (with additional risk overlays), making the current environment favorable for these portfolios. Five of the six funds are actively managed, seeking to provide higher-than-market returns for each of their asset classes. The portfolios also take advantage of the only mutual fund to track the price of gold, the Gold Bullion Strategy Fund, which provides diversification and portfolio safety in periods of equity volatility.

PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS.  Inherent in any investment is the potential for loss as well as profit.  A list of all recommendations made within the immediately preceding twelve months is available upon written request.  Please read Flexible Plan Investments’ Brochure Form ADV Part 2A carefully before investing. View full disclosures.