It was a pretty brutal week for investors. Posting their worst results since March, the Dow fell 4.5%, the S&P lost 4.6%, and the Nasdaq was down by 4.9%. Bond prices rose as their yields again fell. Commodities had a good week, with gold up 2.3%. Oil prices are rebounding from their recent lows, up 2.4% to close at $52.13 per barrel. The international Brent oil, which is used for much of the gas here on the East coast, rose to $61.40.
Well the week ended poorly, but at least it got off to a good start.
The G-20 meeting was held last weekend and investors were relieved to see progress being made on the trade spat between the U.S. and China. The U.S. would hold off on tariff increases while negotiations continued as China promised to buy more U.S. products.
That excitement didn’t last long, however, as Tuesday saw strong selling. The selling started modestly, with the lack of specifics on the tariff truce cited as the culprit behind the decline.
Around noon, though, the S&P 500 crossed below its 200-day moving average (which is just the average price of the index over the last 200 days – it is an important indicator for technical traders). As you can see in the chart below, the markets took a nose-dive that time.
The G-20 meeting was held last weekend and investors were relieved to see progress being made on the trade spat between the U.S. and China. The U.S. would hold off on tariff increases while negotiations continued as China promised to buy more U.S. products.
That excitement didn’t last long, however, as Tuesday saw strong selling. The selling started modestly, with the lack of specifics on the tariff truce cited as the culprit behind the decline.
Around noon, though, the S&P 500 crossed below its 200-day moving average (which is just the average price of the index over the last 200 days – it is an important indicator for technical traders). As you can see in the chart below, the markets took a nose-dive that time.
That sudden burst of selling at that 200-day moving average tells us that the selling was triggered by computer programs. These algorithms were programmed to sell at this level and the selling fed on itself to prompt more selling, resulting in the worst day in two months.
The market fell further again Thursday as the trade concerns persisted. First, we had a tweet from President Trump that got more attention as he is clearly taking a hard line on the trade negotiations:
Then we had the arrest of the CFO of Huawei Technologies, which is a cell phone giant in China. Reports indicated the arrest was for violating sanctions with Iran, but it threw into question the how well the trade negotiations would progress after that.
As investors sell stocks, they often use that money to go into the bond market. This week we saw a phenomenon occur that has occurred before every recession since 1950 – an inverted yield curve.
So what is a yield curve? Without getting too wonky, bonds expire (or mature) at different times. A bond might be for only 30 days or 30 years, with a handful of periods in-between.
As you can see in the chart below, we can plot what these bonds are yielding all along the different maturities. A healthy “yield curve” will see lower yields for shorter-term bonds and higher yields for longer-term bonds. An unhealthy yield curve will “invert” or see higher bond yields at shorter maturities (we won’t get into the “why” at this time).
That’s what happened this week, though only in a small part of the curve – the yield on 5-year bond was less than the 2-year (seen in the yellow line on the chart below). Big deal, you say. It is only a small part of the curve – but it has also happened before every recession so it is noteworthy.
This caused some of the selling this week, too, as investors got a little panicked. We aren’t overly concerned about the market right now as the last three times this happened (2005, 1998, and 1988), the market kept rising for another two years. It is something to keep an eye on though, especially if more of the yield curve inverts.
As investors sell stocks, they often use that money to go into the bond market. This week we saw a phenomenon occur that has occurred before every recession since 1950 – an inverted yield curve.
So what is a yield curve? Without getting too wonky, bonds expire (or mature) at different times. A bond might be for only 30 days or 30 years, with a handful of periods in-between.
As you can see in the chart below, we can plot what these bonds are yielding all along the different maturities. A healthy “yield curve” will see lower yields for shorter-term bonds and higher yields for longer-term bonds. An unhealthy yield curve will “invert” or see higher bond yields at shorter maturities (we won’t get into the “why” at this time).
That’s what happened this week, though only in a small part of the curve – the yield on 5-year bond was less than the 2-year (seen in the yellow line on the chart below). Big deal, you say. It is only a small part of the curve – but it has also happened before every recession so it is noteworthy.
This caused some of the selling this week, too, as investors got a little panicked. We aren’t overly concerned about the market right now as the last three times this happened (2005, 1998, and 1988), the market kept rising for another two years. It is something to keep an eye on though, especially if more of the yield curve inverts.
Lastly, economic data this week was pretty good. The strength of the manufacturing and services sectors looks very solid.
The monthly jobs report was a little soft – though not bad. 155,000 jobs were added last month, well below the almost 200,000 expected. The news was enough to give the markets a lift Friday (albeit briefly), since weaker employment means less chance of the Fed continuing its removal of stimulus.
Next Week
Economic data will be in focus next week. We’ll get reports on inflation, retail sales, industrial production, small business optimism, and another look at employment.
Trade and the Fed will remain in the background and any news from either will have a large impact on the market, especially with investors on edge after last week.
Investment Strategy
Stocks are getting cheaper after this selloff, but not yet at a level we find attractive for new money. We’d also like to see the market internals (like market breadth, etc.) improve before we get too enthusiastic on the market. We thought the market would be higher into year-end, but it’s becoming less likely with every passing week.
There is no change in our longer term forecast, which remains difficult to predict. Fundamentals are still very good with pro-business policies out of Washington providing a solid tailwind. However, higher interest rates have historically pulled markets lower. It’s tough to say where we think the market will go in the longer run.
Bonds are also volatile at this time. Bond prices are extremely high and yields low on a short term basis and we don’t think they have much room to run from here. We think they’ll remain stuck in the range they’ve seen over the last few months, with higher yields and lower prices, but we wouldn’t be surprised to see more volatility.
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 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 prefer developed markets to emerging ones at this time.
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.
Economic data will be in focus next week. We’ll get reports on inflation, retail sales, industrial production, small business optimism, and another look at employment.
Trade and the Fed will remain in the background and any news from either will have a large impact on the market, especially with investors on edge after last week.
Investment Strategy
Stocks are getting cheaper after this selloff, but not yet at a level we find attractive for new money. We’d also like to see the market internals (like market breadth, etc.) improve before we get too enthusiastic on the market. We thought the market would be higher into year-end, but it’s becoming less likely with every passing week.
There is no change in our longer term forecast, which remains difficult to predict. Fundamentals are still very good with pro-business policies out of Washington providing a solid tailwind. However, higher interest rates have historically pulled markets lower. It’s tough to say where we think the market will go in the longer run.
Bonds are also volatile at this time. Bond prices are extremely high and yields low on a short term basis and we don’t think they have much room to run from here. We think they’ll remain stuck in the range they’ve seen over the last few months, with higher yields and lower prices, but we wouldn’t be surprised to see more volatility.
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 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 prefer developed markets to emerging ones at this time.
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.
