A Nontraditional Look into a Traditional Economic Indicator
Sources: Sources for data in tables: Equity Market and Fixed Income returns are from JP Morgan as of 08/16/19. Rates and Economic Calendar Data from Bloomberg as of 08/16/19. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index. Sector performance is measured using GICS methodology.
Global equity markets gave up ground for the third consecutive week last week. In the U.S., the S&P 500 Index, Dow Jones Industrial Average, and NASDAQ Composite retreated 0.94%, 1.40%, and 0.74% respectively. Overseas, developed and emerging markets lost 1.45% and 1.01% respectively. Finally, the 10-year U.S. Treasury yield closed out the week at just 1.55%.
The prior week was the epitome of how August as a whole has played out thus far. It has been a proverbial tug-of-war with investors attempting to determine the eventual direction of the markets. In just five business days:
• we experienced political issues in Hong Kong, Italy, and Argentina,
• we received a bit of optimism around U.S./China trade and tariff negotiations,
• the U.S. consumer once again added a bit of hope to the picture with strong retail sales, and
• a well-known recessionary signal sent markets south.
The recessionary signal, of course, was the yield curve inversion between the 2 year and the 10 year U.S. Treasury – the first time that this has occurred since 2007. Although this inversion has historically proven to be an important signal, correctly predicting the last handful of recessionary periods, we also feel it may be one of the most misunderstood indicators and the consequences may be different this time around than in years past. To help clarify some of the confusion, we note that:
• Historically, a recession has started 20 months after the onset of this particular type of yield curve inversion on average, and
• the S&P 500 Index has historically risen by an average of 12% in the year following this type of yield curve inversion
While a yield curve inversion is nothing to ignore, we don’t believe a recession is necessarily imminent. In today’s complex market and economic environment, we would caution those who demonstrate a myopic view of the situation, that is, viewing this as a traditional signal and acting on that information alone. In addition, we feel forecasts beyond 2020 may not be prudent due to the potential impacts of the results from the elections taking place in November 2020.
We continue to see further growth potential in the U.S. economy to the extent that we don’t believe additional rates cuts from the Federal Reserve (“Fed”) are warranted at this time. However, we recognize that the Fed is under acute pressure by markets and failing to make any additional rate cuts in 2019 may hurt stock prices regardless of any actual economic benefits that may be achieved by such cuts. With that said, the potential for continued headwinds and market volatility remains. Therefore, we encourage investors to stay disciplined and work with an experienced financial professional to help manage their portfolios through various market cycles within a well-diversified framework that is consistent with their objectives, time-frame, and tolerance for risk.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.
The prices of small company and mid cap stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.