Quarterly Update

If you simply looked at the closing numbers for the third quarter of 2019 (Q3), you might have thought the prior three months were pretty quiet. Stocks here at home and abroad generated pedestrian returns, and bonds put up low single digits. But looking back we see that it really was a raucous quarter.

Q3 saw the first interest rate decrease by the Fed in over ten years, followed by a second cut in September. Another part of the yield curve, an important recession indicator, inverted. The U.K. installed a new Prime Minister which led to a ramp up in Brexit headlines. Oil markets had a major price shock (but then quickly came back to earth) when two Saudi oil refineries were hit by a missile attack. Of course, it wouldn’t be a normal quarter without trade-related tweets and headlines. And then, near the end of the quarter, House Democrats began the formal process of trying to impeach the president. Each of these issues moved markets, often at the same time.

Here’s a summary of how major market indexes ended the quarter and year-to-date, respectively (as a reminder, the YTD numbers look very strong, but this is off deep lows last December):

  • S&P 500: up 1%, up 20%
  • Russell 2000 (small company stocks): down 2%, up 14%
  • MSCI EAFE (foreign stocks): down 1%, up 14%
  • MSCI EM (emerging markets): down 4%, up 6%
  • U.S. Aggregate Bonds: up 2%, up 8%

If one event seemed to set the tone for Q3 it was the Fed’s decision in July to lower interest rates for the first time in a decade. Heading into this meeting there had been much discussion and forecasting in global markets about the path of interest rates. Bond investors had been expecting the Fed to indicate a series of rate decreases into 2020. This helped send bond prices higher ahead of the meeting. The Fed didn’t deliver completely on market expectations, even though it lowered its benchmark rate by 0.25%.

This, a slew of commentary about the Fed from the POTUS Twitter account, and lingering uncertainty about the health of global manufacturing, unsettled investors and caused stocks to fall about 5% in August. Stocks eventually made up much of the decline, but the damage was done for the quarter and led to the low return numbers referenced above.  

A beneficiary of this slide was the bond market. Bonds of various types went into rally mode during August as stocks fell. The Barclays U.S. Aggregate Bond Index (the primary bond benchmark) gained about 3% during the month before tapering off a bit into the end of the quarter. This was a big move for bonds that would typically expect 3% in a year.

The increase in bond prices caused the yield, the main measure of a bond’s investment return, to fall to historically low levels during Q3. The yield on the 10-year Treasury (another important benchmark) dropped below 1.4%. These yield movements also caused the yield curve to invert further, adding fuel to commentary about the likelihood and timing of our next recession.

The Fed’s rate cut in July and the second in September were seen by some as “insurance cuts”, or preemptive rate reductions meant to stimulate the economy before it showed more meaningful signs of slowing. Even though consumers are still buying, the job market is strong and so is housing (largely driven by record-low interest rates), bond investors currently expect the Fed to lower rates again in December.

As we end Q3, several different yield curves are inverted, but the 2yr/10yr curve is no longer inverted. This curve was one of the last to invert and was also one of the most noteworthy. A second inversion would likely be an ominous sign, implying a recession to be closer than originally anticipated.

If the last quarter showed us anything it’s how perilous it can be to trade the headlines. Market predictions are especially hard these days when something as simple as tweets can move markets. Accordingly, it’s better (and less complicated) to focus on fundamentals like investment selection, keeping costs under control, rebalancing and, above all, planning for market volatility. Doing so will help keep you sane when it seems like bad news is coming at you from every corner of the compass.

Have questions? Ask me. I can help.

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