Linda S. Parenti, CFA
Chief Investment Strategist
August is not the easiest month for equity investors, and the past few weeks have certainly been a roller coaster ride. Trade tensions between the U.S. and China continue to take center stage. Add to this the protests in Hong Kong, ongoing Brexit drama, and weakening economic data from overseas. Against this backdrop of heightened uncertainties, investor anxiety has been rising, and daily market activity has become undeniably headline driven. For example, stock markets were hit hard Wednesday when the financial media began flashing “recession ahead” banners across screens. The reason for the dire warning; the 10-year U.S. Treasury yield briefly traded below the 2-year Treasury yield, making the spread between the two negative or “inverted.”
Inversions are unnerving to equity markets because the last five recessions have been preceded by an inverted yield curve, and stock prices declined sharply on Wednesday in response. While the 2-year/10-year spread floats between positive and negative, here are some points to consider that may help calm nerves:
• The shape of the yield curve is an important indicator and closely watched because it is easy to track, but it is only one leading economic indicator.
• There have been inversions in the yield curve that were false signals.
• A falling 10-year U.S. Treasury yield typically indicates expectations for weaker economic growth ahead, but even lower global yields are keeping our U.S. Treasuries attractive, which also puts downward pressure on U.S. interest rates.
• When recessions do follow yield curve inversions, they are not instantaneous.
• The lag time from an initial yield curve inversion to the beginning of a recession was between 10 to 36 months for the last five recessions.
• Eventually, stock prices adjust in anticipation of a recession due to expectations for lower corporate earnings.
• However, equity returns on average have continued higher in the months and years following a yield curve inversion.
• For example, the last time this segment of the yield curve inverted was December 2005, two years before the financial crisis began in December 2007.
• In the meantime, stocks continued to do well:
o In 2006, the total return for the S&P 500 was +15.8%
o In 2007, the total return for the S&P 500 was +5.5%
Currently, there are economic data points indicating slower growth ahead, but most are not outright suggesting a recession. There are others which look quite healthy:
• Consumer and small business optimism measures are strong.
• Unemployment is low, and wages are rising.
• Retail sales numbers are coming in much better than expectations.
• Consumer debt as a percentage of income remains low historically.
The bottom-line message is do not panic or let headlines rule your investment strategy. Recessions occur and bear markets happen, but today is not likely the start of either.
RISKS AND IMPORTANT CONSIDERATIONS
Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.