Hi everyone,
Here is the rundown of this week’s blog…
Read Josh’s latest blog highlighting the 8 ways to put cash to work (0:20)
Unemployment holds at 3.6%, lowest in 50 years (0:48)
Largest weekly percentage gain for stocks this year (2:08)
What now for stocks? (3:30)
What bond yield curve “inversion” means and why it matters (5:05)
Portfolio activity (10:47)
Weekly Blog - 06-07-19 from Brian Betz on Vimeo.
(sources: Stockcharts.com, FRED) (Video created using Camtasia)
Have a great week!
Brian E Betz, CFP®
Principal
Three weeks left in the year and we are still awaiting a 4th-quarter rally. With the S&P 500 again negative year-to-date stocks acting pretty volatile, time is running out.
Some stats that might interest you:
If the year ended today, it would be the first time since 1990 that both stocks and bonds finished negative for the year (stocks as measured by the S&P 500 and bonds as measured by the 10-year Treasury bond). In 1990, the S&P lost -3.1% and the 10-year Treasury yield climbed climbed from 7.9% to 8.1%.
A down year for stocks would be the first since 2008, when the S&P 500 fell -37%.
Apple stock, which at one point was up nearly +40% on the year, is now only up +1% in 2018.
The biggest gainer in the S&P 500 this year? The clothing & accessory company Fossil, which is up roughly +115%.
The biggest loser in the S&P year-to-date? Auto part manufacturer Delphi Technologies, which is down roughly -70%.
Bitcoin, which many people had been asking me about this time one year ago, is down -76% in value in 2018 per the NYSE Bitcoin Index (NYXBT).
For what it is worth, the S&P went on to gain +30% that next year in 1991.
The yield curve is extremely close to inverting. More on this below.
General Electric is down -78% from its peak back in 2016.
65% of stock prices among the S&P 500 are below their 200-day moving averages.
The S&P 500 fell -4.4% last week. Let's look under the hood:
(price data via stockcharts.com)
Stocks fell back to the lows from two weeks ago. The overall market continues to look weak. Nothing new there. The bond market was more eventful, as the yield curve gets closer to inverting.
A yield curve “inversion” is when shorter-term interest rates exceed longer-term rates. Specifically, we are looking at the 2-year Treasury bond yield potentially eclipsing the 10-year Treasury yield. Here is where they respectively enter the week:
10-year yield: 2.85%
2-year yield: 2.72%
So we are close. Inversion is totally ass-backward, in that it would mean you could earn a higher interest return lending your money for 2 years than you can lending your money for 10 years. That makes no sense and is not what anyone wants to see. Even if the yield curve does not invert, the fact that the spread between short-term and long-term rates is so slim is problematic enough.
So how does it happen that short-term rates could surpass long-term rates? I believe there are two reasons. First, the Federal Reserve has raised short-term rates aggressively, increasing the Federal Funds rate seven times in just the last two years. Second, long-term rates have sank lower due to renewed demand for long-term Treasury bonds over the past month (remember, higher bond demand means rising bond values, which means falling bond rates).
In an ideal world. the Fed would raise short-term rates as the stock market rises. Meanwhile, the demand for long-term Treasury bonds would weaken because investors prefer being in stocks over bonds. Weaker demand for long-term bonds means long-term rates go up as well.
But lately this has not been the case. Short-term rates have risen, but stock prices have fallen. Meanwhile, investors are migrating back into long-term bonds, which has pushed long-term rates lower. In my opinion, this is the worst trifecta of all: Rising short-term rates, falling long-term rates and stock market stagnation.
I’m not quite at the point of talking “recession”, but there are some signs out there that have me concerned. I’ll lay those out if it becomes appropriate to do so. An inverted yield curve is not required for a recession to occur. However, just know that there has never been a recession without one. It usually takes at least a year though for a recession to occur from the time when the yield curve first inverts, so there’s that.
We sold our Utilities fund position (FXU) last week for a modest gain, which consequently increased our cash position. We will continue to seek out new opportunities, however right now the market is so choppy that it is unlikely we will just yet.
It was a pretty rainy weekend, but despite that we went down to Green Lake on Saturday evening. The entire pathway around the lake was lit up, including a pair of giant hot air balloons that was pretty cool to see. It was a fun holiday outing.
Have a great week!
Brian E Betz, CFP®
Principal
The bond market keeps inching closer to rare territory.
Interest rates are rising across the board. Normally this would be just fine, if not for the fact that short-term rates are rising much faster than long-term rates. This poses a unique situation/problem in the weeks ahead.
The 10-year Treasury bond rate sits just above 3.0%. The 2-year Treasury bill rate is not far behind at 2.6%. If short-term rates eventually eclipse longer-term rates (as shown below), it would mean that the yield curve has "inverted" from a traditional curve. Normally, the longer the bond maturity the higher the interest rate, and visa-versa. Take a look at how the 2-year yield (orange line) has closed the gap versus the 10-year yield (blue line):
(chart created in stockcharts.com)
Notice how quickly the short-term rate has risen relative to the long-term rate? Yield curve inversion could be near.
So is yield curve inversion bad? Potentially, yes. Last month I wrote about this dark cloud of inversion that is hanging over the market. It is often the precursor to a change in the business cycle, which can signal that economic contraction is looming, as it did in the early 2000s and 2008. Take a look at how the stock market (S&P 500, green line) reacted once short-term rates hit their apex in these previous two instances:
(chart created in stockcharts.com)
The two regions shaded in red show where the 2-year Treasury rate peaked, followed by a decline in the U.S. stock market soon thereafter. Before going any further, let's be clear: None of this guarantees that short-term rates have peaked or that the yield curve will invert. Have those odds increased? Yes.
So what would have to happen from here for those two things to occur?
For the yield curve to invert, investors would essentially have to prefer owning long-term bond investments to shorter-term bonds. This would imply that they are comfortable tying up their money for longer periods of time. Such long-term bond demand would push corresponding yields lower. Meanwhile, if short-term rates continue rising -- likely through the influence of the Federal Reserve -- eventually the 10-year rate and the 2-year rate would criss-cross and the result would be inversion.
In a perfect world, long-term rates would continue rising at a pace consummate with short-term rates until business conditions tighten. This tightening could take a number of forms, such as a decline in corporate revenues/profits, a rise in unemployment or flattening wages. As the economy reaches that cyclical peak and then starts to decline, interest rates would then slowly come back down. Lower interest rates would then (in theory) stimulate greater investment via lending and borrowing, which would lead to the start of a new economic upswing.
We know it is never this clear-cut. So if we are looking for the answer to "Is this the market top???" you are not going to find it here. What I would say is this... If the market and economy are nearing a top, I would expect stock prices to remain flat as interest rates creep higher. Eventually, financing would become too expensive and investors would pull back from investing.
But the elephant in the room that might precipitate all of this is that relationship between short-term and long-term interest rates. Long-term rates are meant to be higher than short-term rates, for the simple fact that long-term investments carry greater risk, and therefore, should pay the investor a higher interest return. But if investors decide they are willing to tie up their money for a longer period and only earn a tiny spread for doing so, the yield curve would likely invert. Then it is anyone's guess what immediate impact that has on the stock market and the economy at-large.
The S&P 500 fell -0.5% this past week. Let's look under the hood:
(price data via stockcharts.com)
Stocks just could not maintain the momentum generated coming off the previous week's gains. All in all it was a pretty quiet week for stocks. With interest rates on the rise, dividend-paying sectors (Utilities, Real Estate) were the worst performers. Energy and Materials were the big winners. We are still looking to buy into the Energy sector but would like to see prices come down a bit first before doing so.
In the meantime, as you see below we purchased a Consumer Discretionary fund (XLY) for many accounts. This sector appears poised to make a move higher and based on our technical evidence it made sense to try and take advantage of that.
Finally, to no surprise bonds were down virtually across the board. Long-term Treasuries and Corporate Bonds were both down more than -1.0%. We continue to own a small position in each of these areas in most accounts. I will be looking to sell our Corporate Bond position in the coming week but will likely be a bit more patient with our Treasury position.
I am thrilled to announce that Joshua Baird will be joining our team next month as Executive Administrative Assistant! Josh is a graduate of Pacific Lutheran University and someone I am confident will bring great value and intellect to our firm in the months ahead. I am sure you will have a chance to meet and interact with Josh once he comes on board in June.
Have a great weekend,
Brian E. Betz, CFP®
Principal
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