Market Update August 2019
We got a break from tariff talk recently, but it was replaced by talk of the yield curve, unfortunately. The 2 are probably related, as concerns about tariffs, and Hong Kong, and Russia, have caused some stock owners to sell and reposition to bonds. When bonds are bought, their yields go down, helping to create this very low interest rate environment.
Low interest rates often stimulate stocks prices, which is why the Federal Reserve will sometimes lower short-term rates. Other times, though, low interest rates can indicate a slow economy. I have heard recently that roughly a quarter of government bonds from around the world are trading with negative interest rates. In other words, if you invest in one of these bonds, you won’t get interest…you’ll owe it! So, even though our 10-year Treasury bond only yields about 1.6%, that is still higher than roughly three-quarters of the rest of the world’s government bonds! This is causing more money to flow into our bonds, which pushes interest rates down even more.
Eventually, you get what happened on August 14–a yield curve inversion. An inversion occurs when a long-term bond yields less than a short-term bond, a phenomenon you wouldn’t expect. Bizarrely, right now you can get more interest on a 1-month CD than on a 10-year bond. Than may happen when investors think that growth will slow so much in the future that they are willing to accept lower rates for a longer term.
Yield curve inversions can take many different forms, but the one I look at is the 2-year rate and the 10-year rate. When this pair inverts, it has very good track record of predicting a future recession. Clearly, I’m not alone in watching this, as the Dow Jones Industrial Average sank 800 points when the inversion occurred. What is not at all clear is when that recession might take place. On average, a recession has begun 12-15 months after the inversion, and the inversion occurs at the top of a bull market only about ½ of the time. So, the stock market could continue to rise for the next 12-15 months, or the peak may have been on July 26. No one can know that. And remember, a “recession” is not the same as a “correction,” just like the “economy” is not the “stock market.” They are intertwined, to be sure, but not the same. So, even if a recession never comes, we could get a stock market correction. Likewise, we may not know that we are in a recession until after it has started. Also, recessions don’t have to be as frightening as the 2008 “Great Recession.” Technically, a recession is 2 consecutive quarters of GDP (economic) contraction. So, two mild quarters of contraction may go relatively unnoticed.
What we do know is that in light of these events, now is a great time to reconsider risk. Not everything is doom and gloom. The long-term trend of the market is still intact. Default insurance is not indicating trouble. Consumer confidence is high. If the Fed cuts rates again, money could come back to stocks. But, unless something changes, my plan is to use run-ups in the stock market to reduce portfolio risk. Instead of “buy the dips,” it may become “sell the rips.” I do not think this has to be done immediately. I think we will have time, and I will be reluctant to sell on pull backs. I don’t want to sell at low prices.
As always, these recommendations are mine, and may or may not be the same as those of Raymond James. This is not a solicitation to invest, although we do invite you to review your portfolio with us to see if any changes should be made.
Past performance may not be indicative of future results. There is no assurance any of the trends mentioned will continue or forecasts will occur. Investing involves risk including the possible loss of capital. Asset allocation and diversification do not guarantee a profit nor protect against loss. The forgoing is not a recommendation to buy or sell any individual security or any combination of securities.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Individuals cannot invest directly in any index. Index performance does not include transaction costs or other fees, which will affect investment performance. Individual investor results will vary. Dividends are not guaranteed and must be authorized by the company’s board of directors. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. The prices of small company stocks may be subject to more volatility than those of large company stocks, and therefore, may not be appropriate for every investor. There are additional risks associated with investing in an individual sector, including limited diversification. Investing in the energy sector involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors. Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Scott Mitchell and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Raymond James is not affiliated with and does not endorse, authorize, or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.
The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stocks of companies maintained and reviewed by the editors of the Wall Street Journal. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise. U.S. government bonds and Treasury notes are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. U.S. government bonds are issued and guaranteed as to the timely payment of principal and interest by the federal government. Treasury notes are certificates reflecting intermediate-term (2 – 10 years) obligations of the U.S. government.
