Hello all – we hope your August was less volatile than the market was this month!
August was quite a reversal from the relatively calm market we wrote about at the end of July. The S&P turned in its worst August in four years and closed down over 1.8%. Putting it in perspective, though, the Dow is up over 13% on the year, the S&P has risen 17%, and the Nasdaq is up about 20%.
August was quite a reversal from the relatively calm market we wrote about at the end of July. The S&P turned in its worst August in four years and closed down over 1.8%. Putting it in perspective, though, the Dow is up over 13% on the year, the S&P has risen 17%, and the Nasdaq is up about 20%.
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There were a number of reasons for the return of the volatility.
The month started off on the wrong foot with an escalation in the trade fight with China. Though tensions seemed to cool off by the end of the month, the rhetoric we heard this month was some of the toughest yet. This caused investors to worry and they moved out of stocks and into less-riskier investments.
Some data released this month showed the trade fight has also impacted certain sectors of the economy, like manufacturing. The latest data shows the sector inching towards contraction (in the chart below, a number above 50 indicates expansion, below 50 indicates contraction).
The month started off on the wrong foot with an escalation in the trade fight with China. Though tensions seemed to cool off by the end of the month, the rhetoric we heard this month was some of the toughest yet. This caused investors to worry and they moved out of stocks and into less-riskier investments.
Some data released this month showed the trade fight has also impacted certain sectors of the economy, like manufacturing. The latest data shows the sector inching towards contraction (in the chart below, a number above 50 indicates expansion, below 50 indicates contraction).
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All this negative news caused many investors to worry that a recession may be nearing. In fact, one of the red flags that always appears before a recession showed up this month.
Without getting too wonky: the bond yield curve inverted. Specifically, the yield on the 2-year bond was higher than the 10-year bond. This can be seen in the chart below.
Without getting too wonky: the bond yield curve inverted. Specifically, the yield on the 2-year bond was higher than the 10-year bond. This can be seen in the chart below.
What this means is the interest being paid to investors on a 2-year bond was more than the interest on a 10-year bond. Normally, bonds with longer maturities yield more than ones with shorter maturities. That is healthy. An inversion, though, is unhealthy and is a signal for a recession.
An inversion of a different part of the yield curve has been around for a while now, too. The yield on the 3-month bond has been above the 10-year for several months now. Most economists see this metric as more reliable than the 2-10 spread, but it doesn’t get as much attention.
To that point, the 2-10 yield curve inversion was a popular topic on the news channels as they started to beat their recession drums.
An inversion of a different part of the yield curve has been around for a while now, too. The yield on the 3-month bond has been above the 10-year for several months now. Most economists see this metric as more reliable than the 2-10 spread, but it doesn’t get as much attention.
To that point, the 2-10 yield curve inversion was a popular topic on the news channels as they started to beat their recession drums.
We fear that this will cause a self-fulfilling prophecy. Outside of manufacturing, the economy is quite strong and we’ll touch on this more later. However, the more frequently we hear about a recession, the more we start to believe it and people change their behavior.
We recall a similar reaction by the press in 2007 when the political party opposite of the mainstream media was in power, news reports about a weak economy were loud and frequent. We expect to hear more of this as we head into the election.
We can see from Google Trends that the term “recession” is starting to sink into the collective psyche:
We recall a similar reaction by the press in 2007 when the political party opposite of the mainstream media was in power, news reports about a weak economy were loud and frequent. We expect to hear more of this as we head into the election.
We can see from Google Trends that the term “recession” is starting to sink into the collective psyche:
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We’re also wondering now: Is the yield curve still a good indicator for recessions?
They say the most expensive words in investing are: “this time it’s different.” But we really are in extraordinary times. Central banks around the world have printed gobs of money and lowered interest rates so low that many parts of the world have negative interest rates (for example, it’s like if you had a negative interest rate on your credit card, the credit card company would be paying you to take on debt). Never before has this happened in the history of the world.
So is this action by the central banks skewing the yield curve? We think so and bonds may not be as reliable an indicator as in the past. Although as we said, the most expensive words in investing are “this time it’s different.”
They say the most expensive words in investing are: “this time it’s different.” But we really are in extraordinary times. Central banks around the world have printed gobs of money and lowered interest rates so low that many parts of the world have negative interest rates (for example, it’s like if you had a negative interest rate on your credit card, the credit card company would be paying you to take on debt). Never before has this happened in the history of the world.
So is this action by the central banks skewing the yield curve? We think so and bonds may not be as reliable an indicator as in the past. Although as we said, the most expensive words in investing are “this time it’s different.”
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This brings us to the Fed, which added to the volatility this month.
With all the worries about a recession, investors were hoping to hear more forceful comments from the group that they would be increasing their stimulus as a result. However, they seemed hesitant to commit to anything at this time. This, compounded with aggressive Fed bashing by the President, caused some volatility that sent stocks lower.
With all the worries about a recession, investors were hoping to hear more forceful comments from the group that they would be increasing their stimulus as a result. However, they seemed hesitant to commit to anything at this time. This, compounded with aggressive Fed bashing by the President, caused some volatility that sent stocks lower.
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The Fed really is in a tough spot here (though we don’t feel too sorry for them – they dug themselves a hole with their stimulus and have proven they can’t get out cleanly). On one hand, they have the bond market and the manufacturing sector telling them that a recession is near. On the other hand, data on consumers is amongst the best we’ve seen in a long time and signals there’s no need for further stimulus.
Comments from Bank of America CEO Brian Moynihan reiterated this view in an interview on CNBC this month. By the nature of his business, he can see spending trends amongst the millions of Bank of America clients and he indicates that they are doing exceptionally well.
Comments from Bank of America CEO Brian Moynihan reiterated this view in an interview on CNBC this month. By the nature of his business, he can see spending trends amongst the millions of Bank of America clients and he indicates that they are doing exceptionally well.
Retail companies like Wal-Mart, Target, Home Depot, and Lowes all have a positive outlook, too. They have seen solid business and have raised expectations for the coming quarter. Here’s a look at retail sales:
Optimism amongst consumers is strong too:
And small businesses:
Overall, we think the economy is pretty solid. The only thing holding it back from really accelerating is policy uncertainty regarding trade. The trade fights have shaken businesses and has created hesitancy for them to invest, especially given their unpredictable nature. While the tensions with China seemed to improve at the end of August, this fight has ebbed and waned for years now and is very likely to keep doing so. This is why businesses are holding back.
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Where does the market go from here? Frankly, it’s probably anyone’s guess at this point. The market is moving on unpredictable items like tweets from the President or comments from the Fed.
That said, stocks were on the oversold (or cheap) side at the beginning of this month and never really got much traction to the upside. We think the odds are in the favor of stocks moving higher, but a tweet or comment will probably have more impact on the direction of the market. Like August, September is also a historically volatile month so the volatility may stick around for a while.
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.
That said, stocks were on the oversold (or cheap) side at the beginning of this month and never really got much traction to the upside. We think the odds are in the favor of stocks moving higher, but a tweet or comment will probably have more impact on the direction of the market. Like August, September is also a historically volatile month so the volatility may stick around for a while.
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.
