CIO Mark Nickel's observations going into year end
Are markets currently being driven by hard data OR by interpretations of comments made by central banks and politicians? Fed Chair Jay Powell gave a speech on November 28 that was interpreted as dovish and indicating the Fed MAY not raise rates as much as expected. President Trump and Chinese President Xi are POSSIBLY making progress in trade negotiations between the two countries. Both bond and stock markets are reacting—some might say overreacting—to these comments and not the fundamentals. Clearly, sentiment is fragile. Volatility remains elevated and likely to remain so.
So what do the fundamentals look like? The US consumer continues to look healthy with strong employment, growing wages, high consumer confidence and lower oil prices going into the holiday shopping season. Corporate America earnings will be great in 2018 (up ~20.5%) and while lower in 2019, likely will still grow in the mid to high single digits. Q4 GDP in the US is projected to grow 2.5%-3%. US fundamentals continue to look solid. (Source: Atlanta Fed GDPNow)
What’s this talk of the yield curve? When the yield on the 10 Year Treasury dips below the yield on the 2 Year Treasury, the yield curve is said to be inverted. This has preceded all seven of the last recessions. However, historically the inversion has taken place 87 weeks ahead of the start of the prior five recessions. (Source: Wells Fargo Investment Institute) And keep in mind, the 2/10 is currently flat at 13 basis points; it is not inverted. An inverted curve does not cause a recession; it is a sign that the bond market expects lower future interest rates or lower future inflation.
With that said, what to do now?
- First of all, we are unable to accurately predict what path the markets will take over the short term. We are not saying, and likely will never say, go to cash. What we are saying is that we encourage all clients to work with their Wealth Advisor to make sure the risk in their portfolios is appropriate for what they are trying to achieve (i.e., is your asset allocation appropriate?). If there are cash needs for the coming year, develop a plan to ensure there is a prudent path to provide the necessary funds.
- In equity portfolios, rebalance overweight positions. Take advantage of relatively cheap and out of favor asset classes, sectors or individual holdings. One asset class that is out of favor and inexpensive is emerging markets. Sectors that fit this description are consumer discretionary and financials.
- On the fixed income side of the ledger, we continue to see this as a time to upgrade quality. As we move to the later stages of the economic cycle, it is prudent to reduce the amount of credit risk and we do not believe investors are getting compensated appropriately for the amount of risk they are taking on in lower rated, and in particular, high yield bonds. In addition, with the shape of the yield being so flat, we believe investors should focus on the shorter end of the curve (one-five year) because investors are not gaining much in yield for every year they go out on the curve.
Yes, there is a great deal of noise in markets. Please be sure to check your emotions at the door, focus on fundamentals, and ensure your portfolio’s risks are appropriate.
– Mark K. Nickel, CFP, CIO
Name to Know for December
Prime Minister, United Kingdom
Theresa May came to power in the wake of the "Brexit" referendum, which led to the UK beginning the process of exiting the European Union (EU).
May unveiled her proposed Brexit deal last month to near-universal contempt from Parliament. Since, she has suffered several political defeats, as Parliament reasserted control over Brexit. May’s deal goes to vote Dec. 11, where it is expected to fail. With the Brexit deadline imminent, there are still many outcomes on the table, including a reversal of the Brexit result or a disastrous “no-deal” exit.
US Equities: The S&P 500 returned 2.0% in November, recouping about one-third of October losses.
Global Equities: Developed Market international stocks fell fractionally, but Emerging Markets were up 4.1%. The US dollar index gained 0.2%.
Federal Reserve: Odds of a rate hike on 12/19 are 69%, but futures imply just one rate hike in 2019. Recent comments from the Fed have generally been interpreted as dovish.
US Treasuries: 10-year and 2-year Treasury yields were 2.87% and 2.75%, respectively, as of 12/6. The spread between the two is as narrow as it has been this cycle.
US Credit: Investment Grade and High Yield corporate bonds yield an average of 1.57% and 4.18% over Treasuries, respectively. Spreads have widened in recent weeks, particularly for high yield.
Markets Rundown Source: Bloomberg
Each client’s investment needs, risk tolerance, and goals are different. This newsletter is not meant to be advice for any specific investor. Nothing in it should be construed as an offer to sell, or a solicitation of an offer to buy, any securities. This should not be used as the sole basis for an investment decision. Any opinions or estimates are subject to change without notice. For information about how any of this information applies to your personal financial situation, please contact your Wealth Advisor.
Past performance is not a guarantee of future results.
Although the information provided to you in this newsletter was obtained or compiled from sources that we believe are reliable, J.J.B. Hilliard, W.L. Lyons, LLC cannot, and does not, guarantee that the information or data is accurate, timely, valid, or complete.
All investing involves risk, including the possible loss of principal. You should carefully consider investment objectives, risks, charges, and expenses of any investment before investing. Diversification and asset allocation do not guarantee a profit or guarantee against a loss.
Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market or economic developments. The bond market is also volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect can be more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks.