Summer Swings
We enter the month of September with the S&P 500 at 2926.46 or -3.4% from the all time high of 3027.98, reached in July.
The index SPY is up +2.37% over the past year, while fixed income aggregate AGG is +10.26%, according to Barrons.
Bonds around the world were in the spotlight as sovereign yields plunged.
Defensive sectors of the stock market rose, while economic sensitive and high beta stocks struggled.
As of the end of August, $17 trillion of debt had negative yields. That is 27% of all debt outstanding and 44% of all developed markets debt ex the U.S.
This is a big deal in economic history. Never before have we seen negative yielding bonds persist on such a scale for such a long period of time.
Imagine getting paid for the privilege of holding someone else's money. This sounds like a scene out of that classic film “The Godfather,” directed by Francis Ford Coppola.
Are Governments making investors an offer they can’t refuse?
Switzerland -1.01% for 10-year notes and Germany -0.70% lead the negative yield parade. Japan -0.26%, France -0.40%, Netherlands -0.54% are all on board the train.
Having never seen this film before, we can just ignore it or puzzle over what it means, and how it may affect our investments.
At this moment, we have positive yields in U.S. Treasuries. During August the rate on a 10 year U.S. Treasury note dropped to 1.49%, with 1.96% on 30 year paper. The dividend yield on the SPY is 1.9% by comparison.
Stocks swooned in August trying to make sense of tweets, tariffs, and treasury yield inversions.
Why do 6 month treasuries pay 1.86%, while 10-year notes pay 1.49%? The answer is because investors fear a recession. This is called yield curve inversion.
Why do investors accept negative yields in Germany, Japan, Switzerland, Holland, etc. for so many maturities? The answer is that investors fear a depression!
If the world’s largest economy the U.S. and the second largest China, have a prolonged trade war, perhaps those fears are not misplaced. If the big economic powers slow down, most other economies follow.
Growth in the U.S. has slowed from 3% in 2018 to barely 2% in 2019. This is despite strong employment trends, consumer spending and low rates. China says it is growing about 6%. They are slowing as well.
Most economists forecast no recession in the year ahead, but others now place the probability at 30%. A recession occurs about 22 months after a yield curve inversion on average, according to Credit Suisse.
The U.S. dollar continues to be strong versus a basket of currencies and the Chinese Yuan.
Gold has run up 18.5% year to date in 2019, better than the rise in the SPX. Worries about where to put cash have led to safe haven buying, while Copper is down 13% in the last 6 months. Freight shipments declined in May, June, and July more than 5%.
Central banks have gone to extraordinary lengths to keep economic activity positive, in much of the world. They are now running out of ammunition and ideas to fight the war on deflation. Neither Japan, the ECB, nor the Fed have reached their 2% inflation targets. When rates peaked in 1981, Central Banks were trying to vanquish inflation. Now they are trying to revive it!
The effects of aging populations, advanced technology and sated consumers may have overcome the power of Central banks money creation machines.
We seem to face a binary future. On the one hand trade wars lead to slower growth and likely recession. On the other, a trade truce keeps GDP going and profits flowing. Profits are expected to grow by 2.3%, according to FactSet in 2019.
Riots in Hong Kong appear to be getting worse and that could lead to China’s intervention. This may ironically soften the CCP’s stance on trade, as they want to appear measured and calm after any crackdown in Hong Kong.
Mr. Xi also needs a good relationship with the U.S. We are China’s biggest customer, with $500 billion of imports. China holds $1.2 trillion of our debt and many U.S. companies are part of their domestic supply chain.
We still believe a trade deal is likely before 2020, but markets are skeptical.
Fall is the traditional time for shakeouts and turnabouts. September is often the weakest month for stocks.
Let us root for cooler heads along with cooler weather. Our economy is strong. We have low unemployment, high consumer confidence, and the proven ability to ride out any storm. Stocks generally go up when the Fed eases policy, and more rate cuts are on the way.
As hurricane season is with us, stay safe and keep dry.
Disclaimer: These stock market observations are confidential and proprietary. They are for informational purposes only and are not intended to be used, and may not be used, as investment, legal, accounting, tax, or other advice. No express or implied representation or warranty is being made with respect to their accuracy or completeness. No obligation exists to inform the recipient when the information herein is no longer current or accurate. These observations do not constitute an offer to sell or a solicitation of an offer to buy any securities or interests in any investment vehicles managed by CFA or an associated person or entity, or to provide investment advisory services.
