Since hitting all-time highs at the end of April, U.S. stocks have quickly retreated in May, losing 4.5% from their record peak. Meanwhile, global stocks are down in lockstep from their April highs. How fast narratives change! Last fall, investors were becoming more optimistic that a favorable trade deal might get done and fretted about accelerating inflation and future interest rate hikes. Now, worries center on the lack of inflation and the magnitude of a synchronized global growth slowdown – potentially made worse by escalating trade tensions with China (lower growth, higher inflation).
It’s important to keep this all in perspective by recalling the two main emotions that drive markets in the short run: fear and greed. Fear consumed markets in the final quarter of 2018 as stocks plummeted and investors sought out the safety of government bonds, thereby causing interest rates to fall along with equities. In contrast, greed quickly took over in 2019 as promises by the Fed to halt rate hikes and stop shrinking their asset portfolio aided a strong global rally despite lackluster corporate earnings. Still, even as stocks rallied this year, interest rates have continued to decline, which in and of itself is perhaps telling a different story about the prospects for future economic growth.
Clearly, the global economy is in a sustained slowdown. Evolving trade conditions caused by the combination of tariffs and Brexit limbo, the lagged impact of the Fed’s four rate hikes in 2018, and the sugar high of U.S. tax relief wearing off have indications of global growth dropping to multi-year lows. The U.S., for the time being, appears to still be in expansion for at least the next couple of quarters as leading indicators remain relatively supportive of economic growth.
In March, the 10-year Treasury rate fell below the 6-month rate for the first time since 2007 (an inverted yield curve) which often is a sign of slower growth. The chart above illustrates the last nine times that the yield curve has inverted since 1960. Eight of the nine times were followed by a U.S. recession, but these ensued up to 5-23 months later. Given the current economic conditions, it would seem that we would be at least a couple of quarters, if not more, away from any type of U.S. recession currently. With that said, the track record of inverted yield curves and recessions (89%) is especially noteworthy.
While the stock market rally was certainly welcomed and could easily return on the back of the Fed shifting from tighter to looser monetary conditions, the combination of high valuations, signs of a global market losing steam (global equities haven’t seen new highs since January 2018), and now an inverted yield curve signaling slower growth ahead warrant caution. We continue to maintain our underweight to equities that began last summer as the inverted yield curve adds to signs that equities may be in a topping process. However, we plan to opportunistically rebalance portfolios on further weakness to take advantage of financial bargains that begin to emerge as investor sentiment swings back into the fear camp, thereby taking advantage of our defensive positioning.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, Inc.
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