The Dog Days of Summer were on full display this past month, as a variety of concerns pushed stocks and bond yields lower. After reaching new record highs in late July, the S&P 500 Index dropped approximately 1.8% in August as trade concerns pressured investor sentiment around the world. Impacts of U.S.–China trade tensions reverberated throughout the economy and financial markets in recent weeks, including weakening global manufacturing data and plunging sovereign interest rates. As a result, safe-haven assets like gold, government bonds, and utilities performed well in August.
Escalating trade tensions early last month dashed hopes of a quick resolution. Both sides need to show strength as China is dealing with protests in Hong Kong and preparing for the 70th anniversary of the People’s Republic of China this October, while President Trump is gearing up for the U.S. presidential election.
Fortunately, the U.S. consumer remains in good shape, bolstering the economy. The unemployment rate is low, wages are rising, and debt as a percentage of disposable income remains near four-decade lows. Personal spending has driven U.S. output, which during the first half of 2019 remained slightly above the average for the economic expansion. I believe the key to sustaining growth is renewed strength in business investment, which likely requires progress on trade.
The inverted U.S. Treasury yield curve reflects these uncertainties. An inversion occurs when short-term interest rates exceed longer-term rates and typically indicates pending economic weakness, or recession. Considering the relative strength of the U.S. economy and expected interest rate cuts from the Federal Reserve (Fed), I’m not convinced recession is imminent. Instead, I believe the shape of the yield curve reflects a run on U.S. Treasuries based on the global search for yield. More than $17 trillion in global sovereign debt offers negative yields, where lenders pay borrowers for the “privilege” of loaning them money.
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Another message sent by the yield curve is that monetary policy is too tight given trade uncertainty, so the Fed needs to respond promptly with lower interest rates. Of course, we will have a recession someday, and now that we’re in the longest expansion ever, anticipation is high among economists. Yet reviewing fundamentals, even with trade, I’m hard pressed to project that contraction anytime soon.
In conclusion, fundamentals of the U.S. economy remain solid even as trade uncertainty weighs on investor sentiment. The yield curve inversion should be interpreted as a signal that the Fed is too tight, not of imminent recession. Also keep in mind that stocks have historically performed well in the 12 to 18 months following inversions. As always, I recommend a diversified portfolio to help weather volatility and address a potential recession in the future. If you have any questions, please contact me.
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