Global growth concerns sent equity markets down over 3%.
The selloff affected bond markets, as investors moved to longer dated Treasurys.
We remain cautiously optimistic.
Equity markets are declining sharply ahead of Wednesday’s market holiday to honor the late President George H.W. Bush. Investors are shifting from stocks to longer maturity, safe haven Treasurys. This reallocation has sent bond prices higher, causing bond yields to drop. The yield on 10-year Treasury bonds fell below 2.90% at one point, causing a narrow 0.10% spread between the 2-year Treasurys and 10-year Treasurys.
When investors are willing to hold longer dated bonds with nearly the same yield as shorter dated bonds, it can be interpreted as a sign that investors see future growth prospects as weak. This can also be seen in inflation expectations, which have dipped when you look at the Treasury Inflation Protection (TIPs) markets. Investors are growing increasingly fearful of a recession in the coming years as U.S. growth is expected to slow once the benefits of tax cuts start to fade and the impact of rising costs take effect. Outside the U.S., global growth has been showing signs of weakness all year long. While the U.S. and China put a temporary hold on tariffs, a trade war still weighs on investors’ minds. In addition, corporate earnings are expected to slow from their very high growth rates.
While these concerns are valid, they are not new. We have been watching these risks and warning about them for some time. We also expected more volatility as investors assess these risks. Slower growth concerns will weigh on longer maturity treasury yields. Currently, there is an 80% probability that the Fed will raise rates later this month. Additional rate hikes in 2019 could invert the yield curve, causing short-term yields to be higher than long-term yields. Historically speaking, this is an ominous sign as it has generally preceded a recession by about 16 months. We doubt the Fed would do this and we think future rate hikes may be limited in 2019 assuming yields stay near current levels.
Looking at inflation fears, the dip in recent inflation expectations is largely due to the fall in oil prices, which dropped because of supply side concerns and not demand concerns. Oil producing countries have been pumping more oil recently, causing prices to fall. The drop in oil prices should not be seen as a concern for future economic growth since it is supply related and is less related to demand caused by slowing economic activity.
Looking ahead, we remain cautiously optimistic towards the stock market. Fundamentals in the economy are still strong as the unemployment rate is under 4%, consumer sentiment is high and the U.S. manufacturing index is still rising in contrast with global manufacturing indexes. So, while global growth expectations are weighing on investors’ minds, these are not new concerns. Volatility is likely to continue as investors assess risks. U.S. economic growth was high this year and will likely slow into 2019 and 2020. Gridlock in Washington will likely not produce permanent tax cuts for individuals or other pro-growth fiscal policies. The good news is that the Fed may slow its pace of rate hikes and, if the yield curve inverts, we would not be surprised if the Fed even considered lowering interest rates. With the equity markets selling off, valuations are more attractive too. Valuations especially in growth stocks were getting near 15-year highs earlier in the year. With risks in credit markets and equity markets, we continue to recommend investors to focus on long-term risk and return objectives and not let market gyrations influence these plans. Being diversified across different risks in the market is even more important now.
This report is created by Cetera Investment Management LLC
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Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.
The ISM Manufacturing Index is based on surveys of more than 300 manufacturing firms by the Institute for Supply Management (ISM). The ISM Manufacturing Index monitors employment, production, inventories, new orders and supplier deliveries.
The Purchasing Managers' Index (PMI) is an indicator of economic health for manufacturing and service sectors.
Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period.