Markets continued to see a divergence this week with the Dow posting its second-straight week of gains while the Nasdaq had its second week of losses. Through Friday’s close, the Dow was higher by 0.5%, the S&P was flat with just a 0.05% gain, and the Nasdaq lost 0.9%. Bond yields hit their lowest level since November as their prices rose. Gold moved lower for another week, down 1.2%. Oil was also lower again, off 2.5% to $44.68 per barrel. The international Brent oil, used for much of our gas here on the East Coast, fell to $47.29.
Source: Google Finance
Investors were a little on edge as we opened the week, unsure how the market would react after late-Friday’s strong sell-off in tech stocks. The tech sector has been the best performer so far this year, so many were worried this would bring more volatility and cause selling in the broader market.
While tech stocks continued to see selling pressure this week, it didn’t have much impact on the broader market.
While tech stocks continued to see selling pressure this week, it didn’t have much impact on the broader market.
The tech sell-off isn’t scaring away investors, either, as more new money is coming into the market. According to a company who tracks money flows in the markets, EPFR Global Data, the past week saw the most new money flowing into stocks all year.
Getting into the news of the week, all eyes were on our central bank, the Fed. They held a policy meeting where they announced an increase in interest rates and indicated more would come if the economy performs in-line with their expectations. An increase in rates makes it a little more expensive to borrow money, which is a way of the Fed pulling back on their stimulus. The announcement was widely expected, so it was not much of a surprise to investors.
However, we are hearing more and more investors wonder if the Fed is making a mistake by pulling back on their stimulus. The economy seems to be stalling and recent inflation data has come in below the Fed’s target. A tightening of economic policy in a slowing economy often ends with bad results.
Along those lines, there is an old adage on Wall Street of “Three steps and a stumble.” This means that the market has historically fallen after the Fed raises interest rates three times. The third rate hike of this cycle came in March and the fourth occurred this week, which means we are overdue for a correction.
We aren’t overly worried about a Fed-induced selloff in the market, though. (This next part is a little wonky, but we’ll try to keep the jargon to a minimum.)
The rate that the Fed is hiking is called the Fed Funds Rate, which is the interest rate banks charge each other for overnight loans to meet their reserve requirements. The Fed changes this rate as a way to influence the money supply and the economy.
A rough proxy the market uses for the Fed Funds Rate is the yield (or interest rate) on two-year government bonds (which are short-term bonds that mature in two years).
When the Fed Funds Rate is below the two-year bond yield, it means credit conditions are “easy” and expansionary. A Fed Funds Rate above the two-year bond means the Fed is too tight and it is a restrictive policy.
An easy way to see this is in the chart below – a Bluefin exclusive, I might add. The top is a chart showing the levels of the Fed Funds Rate and the two-year yields. The bottom is the stock market. Notice the green circles – these are where the level of Fed Funds Rate went above the two-year bond, meaning the Fed was too tight. Shortly thereafter, the stock market fell and a recession followed.
Getting into the news of the week, all eyes were on our central bank, the Fed. They held a policy meeting where they announced an increase in interest rates and indicated more would come if the economy performs in-line with their expectations. An increase in rates makes it a little more expensive to borrow money, which is a way of the Fed pulling back on their stimulus. The announcement was widely expected, so it was not much of a surprise to investors.
However, we are hearing more and more investors wonder if the Fed is making a mistake by pulling back on their stimulus. The economy seems to be stalling and recent inflation data has come in below the Fed’s target. A tightening of economic policy in a slowing economy often ends with bad results.
Along those lines, there is an old adage on Wall Street of “Three steps and a stumble.” This means that the market has historically fallen after the Fed raises interest rates three times. The third rate hike of this cycle came in March and the fourth occurred this week, which means we are overdue for a correction.
We aren’t overly worried about a Fed-induced selloff in the market, though. (This next part is a little wonky, but we’ll try to keep the jargon to a minimum.)
The rate that the Fed is hiking is called the Fed Funds Rate, which is the interest rate banks charge each other for overnight loans to meet their reserve requirements. The Fed changes this rate as a way to influence the money supply and the economy.
A rough proxy the market uses for the Fed Funds Rate is the yield (or interest rate) on two-year government bonds (which are short-term bonds that mature in two years).
When the Fed Funds Rate is below the two-year bond yield, it means credit conditions are “easy” and expansionary. A Fed Funds Rate above the two-year bond means the Fed is too tight and it is a restrictive policy.
An easy way to see this is in the chart below – a Bluefin exclusive, I might add. The top is a chart showing the levels of the Fed Funds Rate and the two-year yields. The bottom is the stock market. Notice the green circles – these are where the level of Fed Funds Rate went above the two-year bond, meaning the Fed was too tight. Shortly thereafter, the stock market fell and a recession followed.
What this tells us is the stumble will occur when the Fed Funds Rate (red line) goes above the two-year yield (blue line) – NOT after the Fed hikes rates three times. As you can see in the top chart, the Fed Funds Rate remains firmly below the two-year yield, which means we are not at a level where we should be concerned.
That wasn’t too wonky, was it?
Lastly we’ll touch on economic data from this week, which had several notable reports. First, as we mentioned earlier, inflation reports came in lower than expected. We think this is a good thing because the most prosperous periods in our history came when inflation was low, but the Fed disagrees and wants to see higher inflation. Therefore, the lower inflation reports were seen as a disappointment.
Other economic reports were disappointing, too. Retail sales declined from the previous month, manufacturing took a turn lower, and industrial production was flat.
Below is the latest look at the Citi Economic Surprise Index. We’ve talked about this index a lot lately, which tracks how economic data is faring relative to expectations. The index rises when economic data is better than economist expectations and falls on the opposite.
As you can see in the chart below, the index has fallen sharply (the blue line), which means economic data has been well below expectations. Notice how closely the stock market (the white line) had been following this index. If this trend holds, the large drop in the Economic Index suggests a downturn in stocks is possible.
That wasn’t too wonky, was it?
Lastly we’ll touch on economic data from this week, which had several notable reports. First, as we mentioned earlier, inflation reports came in lower than expected. We think this is a good thing because the most prosperous periods in our history came when inflation was low, but the Fed disagrees and wants to see higher inflation. Therefore, the lower inflation reports were seen as a disappointment.
Other economic reports were disappointing, too. Retail sales declined from the previous month, manufacturing took a turn lower, and industrial production was flat.
Below is the latest look at the Citi Economic Surprise Index. We’ve talked about this index a lot lately, which tracks how economic data is faring relative to expectations. The index rises when economic data is better than economist expectations and falls on the opposite.
As you can see in the chart below, the index has fallen sharply (the blue line), which means economic data has been well below expectations. Notice how closely the stock market (the white line) had been following this index. If this trend holds, the large drop in the Economic Index suggests a downturn in stocks is possible.
Next Week
Next week looks to be relatively uneventful. It’s a quiet one for economic data, with a few reports on housing being the only reports of note.
Also, many Fed members will be making speeches, so investors will be watching closely for any clues about future policy.
Investment Strategy
No change here – we remain cautious on the market. Stocks have had the wind at their back, but rose to a level we found unattractive for new money in the short term. That doesn’t mean stocks can’t keep rising from here, but just that the odds of a pause or decline has risen.
Our longer-term outlook remains a little cloudy. Much of our enthusiasm came from badly needed pro-growth policies being implemented by the Trump administration. There is a lot of pushback against these policies, so reforms may be more difficult. We are a little less optimistic on the market in the longer run, though believe it still has upside potential.
Bond prices look too expensive on a short-term basis.
As for the rest of the portfolio, bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. Floating-rate bonds will do well if interest rates eventually do rise.
Some municipal bonds look attractive for the right client, too. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments.
Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical issues as a flight to safety.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets, though they are looking cheap.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
Next week looks to be relatively uneventful. It’s a quiet one for economic data, with a few reports on housing being the only reports of note.
Also, many Fed members will be making speeches, so investors will be watching closely for any clues about future policy.
Investment Strategy
No change here – we remain cautious on the market. Stocks have had the wind at their back, but rose to a level we found unattractive for new money in the short term. That doesn’t mean stocks can’t keep rising from here, but just that the odds of a pause or decline has risen.
Our longer-term outlook remains a little cloudy. Much of our enthusiasm came from badly needed pro-growth policies being implemented by the Trump administration. There is a lot of pushback against these policies, so reforms may be more difficult. We are a little less optimistic on the market in the longer run, though believe it still has upside potential.
Bond prices look too expensive on a short-term basis.
As for the rest of the portfolio, bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. Floating-rate bonds will do well if interest rates eventually do rise.
Some municipal bonds look attractive for the right client, too. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments.
Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical issues as a flight to safety.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets, though they are looking cheap.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
