Just the Facts
With the recent market volatility, and series of events, that have evolved since our last market note, we wanted to share a piece written by our fellow Investment Committee member, Scott Welch. Scott Welch is the Chief Investment Officer at Dynasty Financial Partners.
Let’s unpack the past few weeks:
- As expected, the Fed cut rates by 25 basis points – and the market tanked. Why? We believe this is primarily for two reasons: (1) because that level of rate cut had already been priced into the market. But what if the Fed had cut 50 bps, as some anticipated? Our opinion is the market would have nose-dived even further, because it would have suggested the Fed saw deeper signs of recession than the market did; and (2) because Fed Chair Jerome Powell suggested in his public commentary that this rate cut should not be interpreted as a signal for further cuts later this year – something the market has more or less priced in.
- In essence, it appears the Fed was in a “no win” situation. If it had not cut rates, the market may have imploded. If it had cut rates by more than 25 bps, the market probably would have imploded, for the reasons stated above.
- But it cut rates by 25 bps, exactly as anticipated. Since, as we have argued for months, it was a meaningless cut in the face of a robust market and still expanding economy, the market “bought the rumor and sold the fact”;
- The new card in the game was President Trump’s threatened additional trade tariffs against China. Since the market had priced in a successful conclusion to trade negotiations, the news that those negotiations are at an impasse (and, in fact, have stalled), made the market very uncomfortable, since there is no such thing as unilateral trade policy;
- Following Trump’s tweets about additional tariffs, three important things happened: (1) China retaliated by allowing the yuan to weaken below the market-assumed barrier of 7:1 to the dollar (making US exports more expensive); (2) China announced a boycott on American agricultural products (which will significantly impact the Midwest economy and, therefore, Trump’s reelection chances); and (3) the US has now officially labeled China as a “currency manipulator”, which has multiple legal and market ramifications.
So where are we now?
- It is important to not over-react to summertime market volatility. Trading volume tends to be less than normal, so spikes (up or down) can be magnified;
- We are paying close attention to interest rates. Global rates have fallen precipitously over the past few months – the result of a slowing global economy and easy central bank monetary policy. We still believe the “inverted yield curve” (as measured by the 10-year minus 3-month spread) overstates the risk of recession anytime soon, but the longer it continues, the more the market will “price in” an impending actual recession – it may very well be a self-fulfilling prophesy;
- To that point, we focus more on the 10-year minus 2-year Treasury spread, and while it remains very narrow (~16 bps), it remains positive;
- Nothing has changed in the underlying fundamentals. (1) The economy is still expanding (though more slowly); (2) earnings are ok (though lower than the past year or two); (3) inflation is rising but still is not a primary threat; (4) employment is strong; (5) interest rates hit low levels that they’ve not seen since 2016 (the 10-year Treasury is currently trading at around 1.70%) ; and (6) central bank policy remains at “full ease”.
People are on vacation and, here in the US, Congress is off for a several week recess. So we expect a generally quiet period as we head into and through the heart of the summer. But while the risks may lie dormant due to general inattention, they certainly have not gone away. While some may enjoy the more relaxed market environment while they can – we suspect things will get “interesting” again once the summer months have passed.
We will close with some previously offered suggestions, which we are doing for our clients – focus on liquidity, quality, and diversification – and pay attention.
Please do not hesitate to contact us with any questions.
*Opinion piece, please see important disclosure page.