The news flow this quarter seems focused on two areas: rising interest rates and the looming deadlines for tariff negotiations. As you probably know “news” is often another way of expressing “things we are watching for negative effects on our portfolios.”
Let’s start with what is worrisome. The US ten year Treasury bond interest rate now hovers around 3%. Why is this significant? For starters, this rate has not been this high since 2014. Rising longer term interest rates might be caused by an expanding economy (good news) but also might be linked to rising commodity prices which can be a serious salvo of incipient inflation. I note that oil has now moved up to $71 for a barrel of WTI crude, and the price of gasoline at the pump has also gone up. Anecdotal yes, but a trend seems to be developing.
We titled our quarterly Listen at Lunch call “The Rise of Uncertainty.” The significant increase in volatility surrounding a first quarter (mini) correction might be indications we have reached a plateau of sorts. When markets approach a turning point, a reversal of trend, we often see more volatility, wider swings between up days and down days. The question for us as investors is this: Are we in early days of this trend reversal or do we have weeks, months or even years before the trend reverses into a bear market?
I watch the Yield Curve for indications of declining markets to come. At present the Yield Curve is still positive, that is, ten year and thirty year Treasury bond yields are still higher than short term bills and notes – but not by much. Today, the two year Note is yielding 2.56%, the ten year Bond, as noted above, is yielding 3.1% and the thirty year Treasury Bond is at 3.23% - very little positive spread between these rates. The pros say the Yield Curve is flattening, which can be a negative signal. For now, it’s a picture of caution but no alert.
Trade tensions and talk of more tariffs (without exceptions) inject more uncertainty into an otherwise positive economic picture. The departure from the Iran nuclear deal appears to be adding to the rapid increase in the price of oil which carries its own brand of economic uncertainty.
Now for the positive part - The economy is strong, unemployment is at record lows, and we await the impact of the corporate tax reform which should boost corporations’ earnings potential. Tax reductions that individuals have seen in their paychecks may add to GDP growth as personal consumption is approximately 70% of GDP. I fear, however, that even modest inflation such as we see at the gas pumps will eat into or eat up the cash flow benefit of the middle class tax cut. The benefit of the tax cut for investors will rest on the profitability of global corporations. Assuming tax relief will add more to their bottom line we should see modest growth in stock valuations in 2018, but probably not as much as we saw in 2017.
This year investors will have to exhibit more of what makes a great investor – patience and fortitude. Prudent levels of cash for any need within the next year might be a good addition to your long term asset allocation plan.
To monitor this rapidly changing investment landscape join us for our next Listen at Lunch conference call in July. Due to the 4th of July holiday (we expect you will all be at the beach/shore/mountains – just not at your desk) the call will be pushed into the next week, so please note that change of date on the announcement email we will send a few weeks in advance.
Wishing you summer fun and relaxation,
Linda P. Erickson, CFP®
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change with or without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.