The Dark Cloud Hovering Over The Stock Market
/Market winds may be going through some real change following one of the stranger weeks we have seen in a while.
Just as it looked like stock prices were set to rally, they went backward Thursday and Friday. The S&P 500 index managed to put together back-to-back weekly gains for the first time since mid-February, yet the week ended on a sour note yet again. Here is how crummy Friday has been as of late:
April 20: S&P 500 Down -0.8%
April 13: Down -0.3%
April 6: Down -2.2%
March 30: (Closed for Good Friday)
March 23: Down -2.2%
Normally I would not make much of a couple days, if not for how bonds behaved in light of the late-week stock slide. Bond prices fell in tandem with stocks, which is surprising because often stock market investors pivot over to bonds when they sell stocks. Such was not the case. Both asset classes were broadly negative the past two days.
Should that persist, it spells bad things for the overall market because it means that interest rates are rising while investors see their portfolio values falling. Rising rates are fine when the stock market is stable, but stocks have been fairly volatile for almost three months running now.
One interesting thing to look at is how interest rates have risen over the past two years, specifically short-term rates. In this case, the 1-year Treasury bill. Take a look:
1-year U.S. Treasury bill yield...
Today: 2.22%
1 year ago: 1.01%
2 years ago: 0.54%
Compare this to the more tepid rise in the long-term 10-year bond rate:
10-year U.S. Treasury bond yield...
Today: 2.96%
1 year ago: 2.24%
2 years ago: 1.85%
It is unsurprising that short-term rates have gone up. That is exactly what the Federal Reserve has influenced through a series of rate increases that began in Dec. 2015 and continue to this day. But the fact that long-term interest rates have not risen at the same pace poses the risk we may eventually see an inverted yield curve.
What is the yield curve? The yield curve is pretty straightforward. The longer you lend your money, the greater the interest rate you would expect to receive in return. This creates a rising curve when charting the relationship between time and interest rates. This is normally what occurs most of the time.
For the yield curve to become inverted, longer-term interest rates would have to fall below shorter-term rates. That means investors are paid more for lending their money for shorter periods of time. If that doesn't make sense that is because it is abnormal and the exact opposite of what we want. Using the example above comparing the 10-year Treasury bond to the 1-year Treasury bill, you will notice how that gap has tightened. Two years ago the spread between the two rates was 1.31%. Today it is 0.74%.
Dark clouds forming: An inverted yield curve would be bad because it likely means a recession is coming, as it did prior to each of the past four recessions in 2008, 2001, 1990 and 1981. It can take months or years for the recession to hit after the yield curve inverts, and as we know, stock prices fall first before the economy contracts.
For now this is something to keep an eye on. It is not something to freak out about. A choppy stock market is not a down stock market. It does make our bond market investing more challenging, as conditions have weakened from where they were even a year ago.
In The Market...
The S&P 500 gained +0.5% this past week. Let's look under the hood:
(price data via stockcharts.com)
It might seem weird to read the ominous tone of what I wrote above and then see that most stock sectors were positive on the week. Last week was more a matter of starting strong and finishing weak, which is the opposite of what we want to see if forced to choose. It shows a lack of momentum heading into next week.
Speaking of weakened momentum, the below chart illustrates this concept well. I often say that what makes a positive trend is a series of "higher-highs" and what makes a negative trend is a series of "lower-lows". Notice how the S&P 500 has again peaked at a lower-high since hitting its all-time high back in late-January (the blue trend-line reflects this):
(chart created in stockcharts.com)
If the S&P 500 falls in the coming days and eventually breaks below its 200-day moving average (roughly 2.5% away) that would be very troublesome. We will respond accordingly if that occurs, but for now the market looks like it will continue moving sideways.
In Our Portfolios...
In Financial Planning...
A common feeling right now is a desire to invest more aggressively. This is to be expected when the stock market (up until February) consistently rises month after month. With that in mind, if you want to be more aggressive you need to ask yourself why...
Is it because your financial situation has significantly improved?
Is it because you feel your risk tolerance has been too conservative?
Is it because someone you trust said you should?
Is it because you simply feel like you should be making more?
Some reasons are more legitimate than others. If your finances have improved then it may very well make sense to get more aggressive. But if you have some fear that you are missing out, yet your financial position has not changed, it does not make sense.
The opposite is true too. If you feel you should invest more conservatively, is that because your financial situation has worsened or because you are simply nervous that the market will crash? The former reason is more valid than the latter.
This is where having a plan and sticking to it comes in. Those who do not plan often end up buying at the market top and selling at the bottom. I am happy to revisit your risk tolerance and portfolio allocations -- both on accounts we directly manage and those we don't. Just let me know.
What's New With Us?
I will be working over the weekend and hoping to finally clean our deck, weather permitting. As a heads up, I will be out of the office on vacation Monday, April 30th until Thursday May 3rd. I will periodically be available those days, but just know that I may not be as responsive as normal.
Enjoy your weekend,
Brian E Betz, CFP®
Principal