January – March, 2019
After a significant correction in the 4th quarter of 2018, the stock market has rallied strongly this year. Over the past year, we have shared our concerns about the level of the stock market due to anticipated Fed policy, trade negotiations with China, political rhetoric coming out of Washington and the overall value of the market in relation to slowing economic data. These concerns led us to take some profits in stocks and increase our allocation to cash. Many of these issues persist today, but a major change in Fed policy has changed the direction of the market.
A few months ago, the Fed was signaling a continuation of rate hikes well into 2020. The Fed recently shifted its outlook and is now signaling that there will be no rate hikes in 2019 and possibly one hike in 2020. Some economists are even calling for a rate cut in 2019. Taking the change in Fed policy into account, we took advantage of the market sell-off and used our cash positions to add some new stocks and extend our bond maturities to maximize income in our fixed income portfolios.
One development we are watching closely is the reason for the change in Fed policy — the slowing global economy. Economists look at a variety of economic indicators to gauge the health of the economy. Some of these indicators, specifically the yield curve, are signaling a slowdown in economic growth which has some economists calling for an impending recession.
You are going to hear and read a lot about an “inverted yield curve.” An inverted yield curve simply means that short term rates, what a bank pays on a 1-year certificate of deposit, are higher than long-term rates, such as a 30-year bond. This is often a precursor for a recession and something that has recently gained ample attention in the business news community. What the pundits on TV fail to point out is that the degree of inversion, and the length of time the inversion is in place, also matters.
Research from Fidelity Investments and Haver analytics show that 64% of the time, the stock market posts positive returns over the 12 months after a yield curve inversion. Although we don’t disagree with the message that an inverted yield curve conveys, we believe there needs to be more thought and consideration when applying it to an investment strategy. This is a very fluid situation, and one that we are monitoring closely. We will continue to make changes to portfolios to balance risk and return as additional information becomes available.
If you have any questions, please give us a call.