A Divided Market

There are clearly opposite views on the market right now.  After a fabulous day for all three indexes yesterday, not to mention the performance of many leading stocks, some commentators remain committed to the idea we are headed for a recession.

A week ago, recession fears were plastered on the front pages of all the major financial news services.  This week we witness a string of outstanding earnings from consumer-based retailers like Home Depot, Walmart, Lowes and Target.  Target hit the ball out of the park sending the stock up 20% on better than expected sales and earnings.

So which view is right?  The one where we are teetering on the verge of a recession or one with a robust consumer and generally constructive economic news?   If you have been following the recession fear story, it is based on the bond market yield curve inversion where interest rates for short-term bonds rise above long-term bonds.  When this takes place a recession often follows.  It is important to note that during ALL of the prior recessions following a yield curve inversion in the last 50 years, The Fed was in an interest rate tightening mode. Today they are easing.  Another important point regarding yield curve inversions and recessions, it can take up to two years from the inversion to materialize.  A yield curve inversion is a noteworthy development, but like many aspects of the bond market, you have to put it into the context of this ultra-low rate environment.

The global economy is slowing, in part due to the trade war with China.  The president has decided the short-term pain is worth the long-term benefit of bringing manufacturing jobs back to the U.S., protecting American intellectual property and preventing China from spying on American citizens.  So far the U.S. economy has been resilient.

The doom and gloom crowd seem to have a reasonable argument.  The rest of the word is having a tough time, The Fed appears confused about what to do with interest rates and tariffs are hurting global trade.

In the U.S. interest rates are on the decline, innovation is alive and well, labor markets are healthy and we had a fairly good Q2 earnings season.

Investors know the likelihood is high we will enter a recession at some point.  Right now, there is simply very little evidence a recession is pending.  Of course, if one happens in the next two years, which is always a possibility, some will gleefully point back to August of 2019 as evidence of the pending event.  The real take away, the timing of a yield curve inversion and a recession is unhelpful in the current environment, in my opinion.

The two biggest factors holding back the U.S. is interest rates and the trade war with China.  So far tariffs have had little effect broadly but that could change as an agreement is delayed.  Interest rates are hopefully headed down, so we are more in line with the rest of the world, which should be good for U.S. investors.  We will know more this week as the Kansas City Federal Reserve host their annual meeting in Jackson Hole, Wyoming.

One more factor about interest rates.  Investors know the Fed controls short-term rates.  But what about long-term rates, why are they so low?  Simply put, demand from foreign investors.  Negative interest rates in other parts of the world is causing money to flow into the U.S. bond market.  That demand causes prices to rise (see chart below) and yields to fall.  This dynamic also causes the Dollar to rise as foreigners have to exchange their Yen, Yuan, or Euros into Dollars to purchase U.S. bonds.

We could explore more about what may be holding back Europe (high taxation, high regulation, liberal social programs) and Japan (immigration policy) in more detail.  In the meantime, we are fortunate to have many investment opportunities to choose from in the U.S.

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