Commentary for the period ending 3-29-19

Hello all, we hope you are well. 

It’s hard to believe, but we’re already about to close out the first quarter.  Stocks have done well so far with the major indexes all up more than 10% over that time.  That makes it the best first quarter since 1998. 

However, the last couple weeks have been more volatile for both stocks and bonds.  This often happens at inflection points – the market will bounce around for a while before starting a new trend higher or lower. 

This volatility has led to a broad divergence in the performance of the different sectors of the stock market.  Some sectors have done very well while others have lagged behind:

The culprit has been worries about slowing growth and earnings. 

While recent economic reports do show continued economic growth, it’s at a slower pace than previous reports.  Economic growth around the world has been even worse. 

Further, many companies have been warning that their earnings for the first quarter are likely to be lower than expectations. 

This has investors a little worried.  

The Fed has noticed these concerns and have been adjusting their economic policy as a result. 

Back in October, the Fed remarked about how solid the economy was and that it allowed them to keep pulling back on their stimulus.  Remember, this stimulus has been instrumental in driving the markets higher over the last decade and its removal isn’t sitting well with investors.  As you can see in our first chart, those October comments sent markets lower and we are just now recovering. 

The Fed has now reversed course and don’t appear to be pulling back on stimulus any time soon. 

In fact, the market has greater odds that we’ll see MORE stimulus this year by the Fed lowering rates! 

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The Fed policy and slowing global growth stories have created a lot of volatility in the bond market.  The Fed prints money to buy bonds to implement their stimulus, while investors move to bonds when they are nervous since they are seen as safer. 

This has made the bond market the big story the last few weeks.

Bonds can be boring, but we’ll try not to make this too wonky…

All the activity in the bond market has skewed it to signal that a recession is very possible.  A phenomenon called a “yield curve inversion” is occurring and it has appeared before every recession since 1950. 

Without getting too into the weeds, the yield curve is an important factor in the bond market, where a graph is drawn to show the relationship between interest rates (yields) and maturities.  Short term bonds traditionally pay a lower interest rate and longer term bonds pay a higher rate.  This is seen graphically where the line slopes upward to the right and is referred to as “normal,” as seen below.

However, sometimes the curve can be “flat” or “inverted,” where shorter-term bonds have a higher interest rate than longer ones.  This is a red flag as it signals a recession is likely.  

Take a look at the chart below, which shows the current yields amongst the different maturities.  You’ll notice that bonds with shorter maturities, like the three month or one year, have higher yields than the 10-year bond.  That’s inversion. 

We can show the inversion graphically, too.

Below is a chart showing the yield on the 10-year bond being subtracted from the 3-month bond yield.  Note the gray shaded areas on the chart – they signal periods of recession.  Also note that they ALWAYS come after the bond yields invert.   

Here is a chart of the 10-year bond yield minus the 2-year bond yield, which is the most watched chart.  It is very near inversion. 

Another good recession indicator looks at the yield on the 2-year bond compared to the rate the Fed has set as its target interest rate.  Every time the Fed’s rate was higher than the 2-year bond yield, a recession followed.  This recently occurred, too. 

Alright, we’re done talking about bond yields.  Maybe this was a little wonky, but it is important to note that investors follow it very closely due to its ability to predict recessions. 

It’s also important to note that a recession doesn’t immediately follow an inversion.  Below is a chart that shows that on average, stock markets peak eight months after an inversion and the recession hits 17 months later. 

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After that doom and gloom, how does the market look going forward from here?  Stocks have risen nearly 20% since their lows in late December and that pace can’t keep up forever.  While we don’t see big gains in the near future, we aren’t seeing any red flags that often appear before a big decline. 

Like we mentioned just above, though, we have to be careful a little further down the road.  Investors will be closely watching first quarter economic data and earnings reports that will begin coming in the next couple weeks for any signs of weakness. 

That said, stocks appear a little on the expensive side and we aren’t enthusiastic about putting new money in here.  We aren’t doing any selling, but not actively buying, either.  



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.

Commentary for the period ending 3-1-19

Hello everyone.  We’ve just flipped the calendar forward to March and hope your February was nice. 

The month was a good one for the markets.  The S&P 500 rose 3.2% and the Dow was up more than 4%.   

Following the solid performance of January, it put the gains for both indexes above 11% for the year so far. That makes it the best start to a year since 1991 and also ranks among the best starts ever.  

Our next chart shows a breakdown of the performance of the different sectors.  It’s interesting to note that the best sector has been the industrials (which is made up of many manufacturing and transportation companies), since they are rarely the leaders. 

The reason for the outperformance is largely due to China and the likelihood of a trade deal.  These stocks were hit hard in the ongoing feud and as the odds of a trade deal rose, these stocks have risen.  

The improving relations with China have played a part in this rise in the market, but there have also been several other factors. 

As reported in our last commentary, the Fed is no longer as adamant on removing stimulus.  Over the last few weeks they have continued to reinforce this idea and stocks have moved higher.  While the stimulus has been good for the market, we do have concerns that it creates larger problems down the road, but that’s a different conversation for a different time.   

Economic data remains decent as nearly all metrics are showing growth.  GDP, for example, was released this week and came in much higher than expected.  

Employment looks good, too, especially when you see articles like this:  

Lastly, corporate earnings for the fourth quarter have also been coming in above estimates. 

With nearly all companies in the S&P 500 reporting results, Factset reports earnings growth of 13.1% and revenue growth (which is the money made by sales.  Earnings are what remain after costs are subtracted) of 5.2%.  These are respectable numbers. 

However, there is a concern that this is the peak of earnings.  Factset is reporting an estimate of negative earnings growth in the first quarter of this year, although sales (or revenue) should continue to grow.  Earnings have been extremely strong recently so it’s natural to see a decline at some point, but it’s still something to keep an eye on. 
 

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How does the market look going forward?  Stocks have risen nearly 20% since their lows in late December and that pace can’t keep up forever.  While we don’t see big gains in the near future, we aren’t seeing any red flags that often appear before a big decline. 

That said, stocks appear a little on the expensive side and we aren’t enthusiastic about putting new money in here.  We aren’t doing any selling, but not actively buying, either.  

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.