Unless you have somehow managed to disconnect yourself from the world this week, it is not new news that market volatility returned in earnest. For those who have been following us for some time, we have been consistent in our message that we do not believe markets can be timed. Nothing has changed.
We have been diligent in trying to remain a steady hand to you during good and challenging markets. As a reminder, on May 10th, we communicated that the inflated returns we had seen earlier in the year were likely unsustainable. We attempt to stay balanced in our commentary, using common sense, a consistently applied strategy, and a level head to cut through the noise of data and media that can sometimes seem overwhelming.
You may have noticed in your respective news feeds this week that on August 14th, the 10-year U.S. Treasury interest rate fell below the 2-year U.S. Treasury rate for the first time since 2007. This occurrence is referred to as yield curve inversion and generally happens prior to an economic recession.
According to J.P. Morgan Research, 7 out of the 8 U.S. yield curve inversions since 1960 were followed by a recession. Also, according to their research, the number of months between a yield curve inversion and a subsequent recession has ranged from 3 months to 24 months. So, it is important to understand when the yield curve does invert, historically, recessions do not necessarily immediately follow, if at all.
A few important notes:
- Some foreign economies, like Germany and Japan, are experiencing more drastic slowdowns and currently have negatively yielding bonds. This means their customers must pay banks to hold their money rather than being paid an interest rate. Sounds crazy, right? But it’s true. This, in turn, makes higher yielding U.S. treasuries very attractive and, as a result, U.S. bonds are being purchased in large amounts driving down their yields as well.
- A portion of the slowdown in international economies is being driven by uncertainty over trade tariffs. A trade resolution between China and the U.S. would most likely have a stabilizing effect on yields. Trump delayed the enforcement of some tariffs until December, but we expect that to be back on the table during the critical retail holiday period.
- Demographics are also a driving force. An aging population in Europe, Japan, and in the U.S. is creating strong demand for U.S. bonds which then drives interest rates lower (bond prices are inversely correlated to interest rates).
- The U.S. economy continues to have record low unemployment, productivity growth, and other healthy economic indicators. While growth has slowed, normal economic indicators are not necessarily signaling a recession.
In summary, an inverted yield curve has been a reliable indicator that a recession is likely in the next 1-2 years. Obviously, there are no certainties, if and/or when. But, you might ask, “If a recession is likely according to history at least, why not get out now?” The basic answers:
- We don’t know “if”
- If a recession does occur, we don’t know “when”. Mark DeCambre at MarketWatch illustrates that markets have generated positive returns anywhere from 3 months to 3 years after the initial inversion.
- If we did get “out”, deciding when to get back “in” is as risky/dysfunctional as deciding when to get “out”
- There are several other inconsistent indicators currently that make the correlation to other historical recessions…well, just that - inconsistent.
As a result, we remain consistent in our application and strategy; risk appropriate, diversified portfolios across countries and asset classes. History has proven that it is nearly impossible to time these things and the best course of action is to stay invested (again, this is the same message we shared with you on May 10th). We will continue to monitor your portfolios, rebalance as appropriate and look for substantive tax loss harvest opportunities in your taxable accounts should they present themselves. As always, we are standing by for any questions you have.
Posted on Fri, August 16, 2019
by Kimberly Victoria filed under