July 2019 Thoughts and Insights
This past June, the Fed surprised the markets by changing its outlook from a neutral stance on the economy to a more cautious and dovish stance. Otherwise stated, they are contemplating lowering interest rates again. The result of this outlook change caused the S&P 500 to re-visit all-time highs. On the surface, this would appear to be “good news” for the markets and our equity portfolios have had nice gains. Additionally, our bond portfolios have also had nice gains as the 10-year bond yield drifted down near 2% (when rates go down, prices go up). Modern Portfolio Theory says that you cannot continuously have gains in both, so one of the markets is hiding something. The big question is which one…
The equity bulls say valuations are slightly expensive but reasonable. Liquidity is readily available and companies are flush with cash. Unemployment is at all-time lows. The market anticipates two more rate cuts in 2019 which means the Fed will continue to “goose” the market upwards like they have since the 2008 financial crisis. Lower rates, in theory, are good for companies and their stock prices. You may have heard of the investment mantra “don’t fight the Fed”. This means when the Fed lowers rates, the mass market will remain heavily allocated to stocks.
The key question facing the fixed income market is whether the economy is just slowing down, or if a recession is near. The Fed’s June rate cut signal was in response to signs of economic weakness, presumably to avoid a recession. If the economic outlook improves, the 10-year treasury could range between 1.8% and 2.5%. However, if the economy continues to deteriorate, and a recession appears likely, the rate could fall as low as 1.5% (taking fixed income prices higher).
The bond market is mindful of the inverted yield curve, trade/tariff war fallout, and falling economic data. However, recessions are often triggered by some shock to the economy or unknown lurking bubbles that are not easy to see in advance.
Lastly, it is worth mentioning the launch of the 2020 race for the White House. Currently, Joe Biden remains the front runner on the democratic side, followed by Bernie Sanders, Kamala Harris, and Elizabeth Warren. Three of the top four democratic candidates are beating Trump in the most recent national poll (all except Warren who is tied). It is far too early to draw any conclusions, but the market impact from the election will likely be relatively significant as issues such as health care, tax policy, global trade, the Federal Reserve could be affected.
At DTIM, we continue to walk this “tight-rope” trying to be smart and cautious with both our equity and fixed income portfolios. Moving forward, we plan to increase our exposure to historically defensive equity sectors such as REITs and Utilities. We believe these underlying positions should provide a reasonable income stream, reduce our cash balances, and deliver appropriate downside protection. On the fixed income side, we are reducing credit exposures and adding US treasuries.
As always, we remain dedicated to serving your investment needs according to your goals. Please call or write with any questions you may have or join us in the lounge with the beverage of your choice for enlightening discussions.