We are staying on top of some key economic developments this quarter. While you don't have to read economic news if it doesn't interest you, periodically it is good to check in to understand how your portfolio may be affected. While shifts are being made constantly in this ever changing landscape of the economy, here is a review of the current economic outlook and interest rates.
The biggest concern for the market right now is a sentiment of uncertainty.
This sentiment is coming from multiple sources including:
The upcoming presidential election in 2020
The Chinese trade war concerns and tariffs
Inflation expectations and the inverted yield curve
Wage & job growth
The political and trade war uncertainties are the biggest of the four concerns, as they are the largest unknowns with the most risks to the market. The two largest world powers in a trade war does not bode well for the economy and GDP (gross domestic product). The US and China are supposed to meet at the G-20 summit this Thursday (6/27/19) and it is hard to know what will happen. Economists assumed that the US and China would have come to an agreement by now - it has not happened but they are still optimistic. The reality is that if a deal is not made this week, we will likely see more volatility in the markets.
Inflation Expectations - We could see rate cuts.
Economists expect to see rate cuts this year because of the current market uncertainty. When the Fed was making rate hikes last year it was because of the strength of the market and in hopes to get the US back to a normal inflation range after being very low for the last decade. But, with the uncertainty looming and especially with the trade war with China still unresolved, there is a heightened concern for a recession.
In preparation for a need to do more quantitative easing, if a recession were to happen, the Fed in the June meeting did not raise rates. The Feds are giving themselves time to see where the market goes. The Fed at the June meeting said they will act with "patience" in making any adjustments to monetary policy.
President Trump is pushing for a rate cut but it seems the Fed is not succumbing to the political pressures yet. The FOMC (Federal Open Market Committee) will meet again in September. Economists assume at the next meeting there will be a higher likelihood of a cut if the uncertainty of the market is still present.
Economists also noted that they believe that inflation changes are already priced into the market after the backsliding of the inflation rate from 2%. This means that any new changes to inflation are likely already reflected in stock market prices and it should not have a large impact on the market if inflation reduces again.
Inverted Yield Curve - Why is this important?
We are currently seeing an inverted yield curve in bond markets - this means the 10 year treasury bonds are trading at a lower yield than the 3 month treasuries. This is not normal. In the bond markets, longer duration bonds usually carry a higher risk and therefore are rewarded with higher yields. Inverted curves happen when the economy is seemingly uncertain about the future or it determines yields will be low for longer periods, like during a recession. This is why an inverted yield curve is a traditional signal for a recession.
There is one school of thought from economists which is that all the quantitative easing that has been done by the fed might have exacerbated the yield curve and that it could be less of a signal for a recession than before. Vanguard Senior Economist, Andrew Patterson, did not agree with this hypothesis.
The inverted curve, while it could be signaling a recession, it does not mean it will happen immediately.
Where is the US in the economic cycle?
An economic cycle, also referred to as the business cycle, has four stages: expansion, peak, contraction/recession and trough. The economic cycle is a trend that is seen repeatedly in the markets. Patterson, said on the 2019 Vanguard Market Outlook webinar, that the US is in the late middle to early late stages of the economic market cycle.
This would put us in the peak or just coming off the peak and starting into the recession stage - aligning with the inverted yield curve signal. Though for the last 3+ years many economists assumed we were at the peak of the market - yet it has been quite steadily growing. While this is an educated guess as to where we are in the cycle, it is good to remember that hindsight is 20/20 and it is very hard to tell in advance where exactly we are currently.
Recessions come in all shapes and sizes.
While a potential recession can be a scary thought, it does not mean it has to be as bad or as long as the Great Recession in 2008/2009 or the Great Depression - the most notable bear markets in US history. Even if we are in the contraction stage of economic cycle, we do not need to prepare for a doomsday.
The average correction for the S&P 500 since World War II lasts four months and sees equities slide 13% before bottoming, according to analysis at Goldman Sachs and CNBC. But if the correction turns into a bear market the average length rises to a little over a year with markets dropping on average 30%.
There is a bright side to a recession - market downturns are a great time to buy into the stock market at very low prices.
If you haven't had your portfolio reviewed recently - it is time.
Now is a great time to meet with your CERTIFIED FINANCIAL PLANNER ™. If you have not recently had your portfolio reviewed or rebalanced in the last 12 months, now is the time to make sure your asset allocation is aligned with your goals and your risk tolerance. If you are getting closer to retirement or needing to pull assets from your portfolio it becomes even more important to have your portfolio reviewed on a consistent basis.
Do not make drastic shifts based on headlines.
During times like these it is hard to not be an emotional investor. Just remember, headlines are click bait and are made to scare you. If you are a PWR investment management client, we will alert you when we deem it time to make any necessary changes to your portfolio based on market movements.