What's Going on with Stocks?

What’s going on with the stock market? That’s a question several of you have asked in the last week. I thought I’d answer the question here as well since I’m sure others are also wondering. The short answer is that this is a normal bout of volatility that is part of getting good long-term returns. But since the slightly longer answer is usually more interesting, here goes…

Although stocks have logged decent performance of about 4% in the past 12 months, you’d be forgiven if you felt like it’s been a bit of a rollercoaster ride getting there. We had all that volatility to end 2018 when stocks fell almost 20%. Then we had a good upsurge to start 2019, only to be followed by stocks falling 6% in May. These gyrations are due in large part to several risks, some of which are new while some could be considered old (but persistent) news.

We’ve previously discussed how we’re nearing the end of the economic cycle that began during the Great Recession. This is old news. As the cycle starts to slow investors get nervous and headlines that might otherwise get overlooked take on greater significance. For example, it turns out Google may be subject to an antitrust investigation by the Department of Justice, and possibly Amazon and Facebook as well. Since the tech industry makes up nearly a quarter of the S&P 500, the long-term viability of the business models of these companies matters a great deal. I don’t know that these antitrust revelations are necessarily new, but they contribute to a growing sense of anxiety within the stock market.

Piling on last month was worsening geopolitical and trade news. We learned that British PM Theresa May was resigning after failing to deliver Brexit. This almost ensures another down-to-the-wire ordeal come October when their extension to leave the European Union ends. Continued disfunction around Brexit adds to fears about the structure of the EU itself. Taken to the extreme, the EU collapsing as other countries with nationalist tendencies try to leave would obviously have far-reaching ramifications. On top of this we learned of more tariffs from the Trump Administration directed at China and, at month’s end, potential tariffs aimed at Mexico. All of this raises the tension level in the room, so to speak.

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Investors are also concerned about interest rates and Federal Reserve policy. One of the metrics the Fed tracks, and has been trying to boost, is referred to as “core inflation”, an inflation gauge that strips out more volatile food and energy prices. The Fed has a stated goal of 2% core inflation, but we’ve been persistently below that level (currently about 1.6%) for years. This, plus the “lateness” of the economic cycle has some bond investors thinking the Fed may cut interest rates sometime in the next year. Currently the bond market is pricing in an 88% chance of a rate cut by December. The bond market could be wrong about this, but either way it’s a dramatic change from recent history when most investors were concerned with rate increases!

Another impact from all this is that the yield curve, something we’ve discussed in previous posts, has “inverted” further. Today, if you wanted to buy a 30yr Treasury bond you’d be locking in only 2.6%. Ten years would get you 2.1%, two years 1.9%, but three months would yield more at 2.3%. This doesn’t seem right, does it? If you loaned money to the government for ten, or even 30 years, you’d expect to be paid more than you would for something short-term.

But changing investor demand for bonds at these different maturities has upset the market and caused bond prices to rise. From a portfolio standpoint this has been good for investors with a more balanced allocation that includes stocks and bonds. For example, while stocks have fallen in recent weeks, bonds have risen, up nearly 5% so far this year and almost 2% in recent weeks. As expected, this performance from bonds helps mitigate the impact of falling stock prices. It doesn’t work dollar for dollar, percent for percent, so to speak, but it helps.

I would assume the current runup in bond prices is probably overblown and could taper off in coming weeks. Unfortunately, all of this is common when we’re late in the economic cycle. As we’ve discussed before, what comes next is recession so we should all be on the lookout and not be too shocked when the economy starts to turn sour. Is it time to head for the hills? No. History indicates a recession could be a year or more in the future, but time will tell. In the meantime, we want to stick to our game plan even though it may feel uncomfortable at times.

Have questions? Ask me. I can help.

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