Investment Insights: The dichotomy of directions
This weekly report presents insights from our Global Investment Management team.
The Global Investment Management team has been concerned about the relative trends of equity and bond markets since the beginning of the year, following the complete reversal of the Federal Reserve’s rhetoric in three short months.
In December’s Fed minutes, the implications of a tighter job market and potential wage increases were enough of a concern that reserve members forecasted three rate hikes in 2019.
Hawkish tones regarding the balance sheet run-off propelled equity markets down into correction territory by December 24. Since that trough, the market has regained most of the loss and is up over 23% on the S&P 500 Index. In January’s Fed meeting, Chairman Powell walked back earlier statements and communicated a message of patience and flexibility.
This all culminated in March with assurances from the Fed that interest rate hikes would remain on hold for all of 2019. Fed funds futures are showing the market is now pricing in a possible rate cut this year in contrast to the end of 2018 when one hike was predicted. This brings us to today and the almost straight up trajectory of equity markets, while bond markets indicate darker times are ahead with the most recent, temporary inversion of the yield curve between the 3-month and the 10-year. Although an inversion isn’t a perfect predictor of a recession, it is a pretty good indicator of a rate cut in the near future.
The reality is that one of these two mindsets must be incorrect and convergence will need to occur. Recessions or recessionary fears and strong equity markets generally don’t overlap for long. However, investors have to ask whether this is just a scare, in which case equity markets are priced accordingly, or whether this is a prelude to the “R” word?
To some degree, the bond market has backed off a bit with the 10-year Treasury rising from a low this year of 2.37% seen on March 27, and now trading at 2.47% which equates to approximately 5 basis points difference between the 3-month and the 10-year with inversion still occurring from the 3-month through the 7-year. Additionally, the soft inflation reading today reinforced some market predictions that the Fed will indeed have to pause hikes or potentially stimulate if inflation does not percolate through the markets.
There are some positives to point to that the equity market would remind investors to consider. These include: strong employment data, positive albeit slower economic growth, a potential respite in Brexit negotiations, fewer downgrades to corporate profit growth, and expectations of some trade deals being worked out. Furthermore, a soft GDP in Q1 should be taken with a grain of salt as adverse weather conditions across the country and the government shutdown resulted in stunted growth, both of which will likely work themselves out in Q2. However, that’s not to say we will see growth equal to that of 2018.
All this makes the Global Investment Management team a bit nervous about the continuation of equity asset rallies in the intermediate term. The team reiterates that it is cautiously overweight to equity markets with the recent rally being a nice respite from the end of last year, and an opportunity to possibly take profits. The S&P 500 has almost reached its 2018 high, and emerging markets have reached a high unseen in 10 months, as indicated by the MSCI Emerging Markets Index. For now, the team believes that both market bets might be a bit misplaced with stocks perhaps a little exuberant and bond market predictions a bit too dire.
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Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.
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