Market update: August 2019

Blog post #408

The past 4 weeks have been full of financial news and events….
  • Stock markets have dropped and risen,
  • Interest rates have dropped significantly
  • Trade war tensions have continued to escalate
  • There is more talk of a potential future recession in the US.

Despite all this financial volatility, US large company stock market indexes are still within approximately 5% of their all-time highs.

If you are concerned about the news, these financial changes or market volatility, please contact us so we can talk. We can discuss these events with you and review how they may impact your financial goals, objectives and your portfolio.

Before we review some of the economic details, it is important to remember some investment principles that we believe are in your financial best interest:

  • You should focus on what you can control.
  • You should not panic or make reactive decisions. You should make financial changes and important decisions for the correct reasons, such as changes in your life or financial circumstances, not in reaction to short term events.
  • Not making major portfolio changes is a decision. Sometimes, inaction is actually a rational decision.

There has been more talk recently about recessions, either in the US or on a global basis. A recession is two quarters (6 months) where the economy declines, or fails to grow. A recession is a normal part of long-term economic cycles. There has not been a recession in the US in over ten years. 

We do not feel that the US is on the cusp of a recession right now. There could be one soon….or the next one could be years away. We know there will be another recession at some point in the future, we just do not know when. We know this just as we know that the stock market will reach new highs, but will also go down as well. We just can’t time when recessions will occur, just as it is extremely difficult to predict stock market tops and bottoms.

Based on actual, empirical economic data, the US is not in a recession today. Based on recent sales and earnings reports, it is clear that US consumer is still very strong. Retailers like Wal-Mart, Home Depot, Lowe’s and Target reported over the past 7 days that customers are spending more, not less. If we were in a recession, or heading that way, the reports would not have been anywhere as strong as they were.

The tariff and trade tensions between the US and China may be impacting US corporate spending and investment, as well as affecting the purchases of US products by companies based in other countries, but there is not clear evidence that a global recession is ongoing.

Normally, in a healthy economy, interest rates on bonds and other fixed income investments go up as their maturity’s lengthen. This is called a rising yield curve. For example….

  • a one year bond would pay 2%
  • a 5 year bond would pay 3%
  • a 10 year bond would pay 5%

After the Federal Reserve lowered short interest rates on July 31st, President Trump reheated the trade war with China. Since then, various economic moves have been made by central banks worldwide, as well as increasing purchases of US government bonds by foreigners, has resulted in very fast and significant drops in US interest rates.

The yield on the 10 year US Treasury Note dropped by almost 25%, from above 2% in late July, 2019 to around 1.55-1.60% in the past two weeks. In stark contrast, during late October, 2018, less than 9 months ago, the yield was above 3.2%.

As a result of these dramatic drops in interest rates over the past month, parts of the US government bond yield curve is inverted, meaning it is not steadily sloping upwards, parts are now sloping down.

As of Wednesday, August 21, 2019, the yield curve reflected:*

As a result of these interest rate movements, and the partial inversion of the yield curve, some feel that the bond market is signaling an oncoming recession. There is past evidence that an inversion of the yield curve has preceded all post-war recessions, but not all inversions signal imminent recessions.** And, sometimes these recessions took 18-24 months following the initial yield curve inversion to occur, so it is not like a flashing light that something will automatically occur in exactly 4 weeks. It is a blurry, potential signal, at best.

Global interest rates are very low and in many foreign countries interest rates are negative, in an effort to support their economies. This may be causing even more demand for US government bonds, which still pay positive interest yields. This increased demand for US government debt may be a significant factor in what is causing US interest rates to go even lower over the last month.

These may be some of the global causes of the inversion of the US yield curve. As interest rates are already so low and the yield curve so flat, the inversion may not necessarily be an imminent sign of an upcoming recession.

We do not think the US or the global economy is currently facing a serious economic event, such as what occurred around 2008-2009. However we cannot predict the future. We can just try to review the data, read and listen as much as we can, and try to provide you with guidance, clarity and explanations.

The other critical element that must be remembered is that economies and stock markets are not directly tied to each other. Both are hard to predict. Even if you could predict a recession’s beginning and ending, it would not necessarily make you a more successful long term investor.

You will be much better off focusing on your long-term goals, remaining disciplined and adhering to your financial plan (Investment Policy Statement), than trying to predict or worry about the next recession or trying to time the stock market.

Sources:

*“US Yield Curve,” WSJ.com, as of August 21, 2019 and as viewed on August 22, 2019.

**“Recession Fears Are Overblown,” Wall Street Journal, page A15, Andy Puzder and Jon Hartley, August 21, 2019 (Opinion page)

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