In the April issue of our monthly flagship publication, we feature:
- On the Record by Chief Investment Officer Tony Roth, where he sorts through a bevy of mixed economic data and brings clarity to the various leading—or perhaps misleading—indicators in determining how heavily to weigh each and whether to conclude that we are on the cusp of a recession.
- In Focus by Chief Economist Luke Tilley, in which he takes a masterful turn at explaining the method to the Federal Reserve’s “madness”—as far as its rationale in deciding whether or not to hike short-term interest rates
- Investment positioning, major themes, and asset class positioning updates.
Ten years after the trough of the S&P 500 and we are clearly deep into the economic cycle. Consequently, at each softening of the economic data, it is tempting to call the turning point in the direction of growth. Many market participants are reacting to recent developments in just this way, and recession-related anxiety is running high. By contrast, our reaction to that same information is, “Not so fast.”
Consider the following sequence of recent events: On March 20, the Federal Reserve announced no change to its policy rate, but the FOMC—the committee that sets the direction of monetary policy—lowered its expectations for further policy tightening, signaling no further rate increases in 2019. It made only minor reductions to future growth and inflation projections and also announced an early end to its “quantitative tightening” policy of shrinking its balance sheet. This was an unequivocally “dovish” Fed meeting that would have normally been met with enthusiasm from equity investors and a steepening of the yield curve (i.e., bonds selling off).
The next day, business activity surveys in Europe massively disappointed, with indicators of the manufacturing sector falling deeply into contractionary territory. International bond yields fell, with the yield on the 10-year German bund moving back into negative territory for the first time since October 2016. (As a reminder, a negative-yielding government bond means an investor pays for the right to lend money to the government.) Concerns about spillover risk coupled with a hunt for yield brought the 10-year U.S. Treasury yield to below 2.4% from 3.2% just five months earlier.
Two days after the Fed meeting, the slope of the Treasury yield curve inverted between the 10-year and 3-month tenors (meaning the 3-month Treasury was yielding more than the 10-year, an indicator of slowing future growth that has preceded every recession in the last 60 years). Meanwhile, the sibling of the 10-year/3-month curve—the difference between the 10-year and 2-year yields, which has historically moved with the 10-year/3-month slope and also preceded prior recessions—has actually steepened, as the market has now priced in two rate cuts by the Fed beginning as early as September 2019. In other words, one recessionary signal is flashing red, yet another very similar one is yellow moving closer to green. Through all of this, equity volatility and credit spreads have remained well behaved.
So how exactly does one go about positioning portfolios in an environment characterized by such a myriad of conflicting data points?
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