Halloween Arrives Early: Investors Spooked By Swift Rise in Bond Yields – 10/11/18

What a difference 8 days can make!  After turning in the best quarterly performance in several years, the new month and start of 4Q has been no friend to investors.  If you’ve been following the financial media at all in the last week or so, you are aware that the recent market stress is being attributed to a swift upward adjustment in bond yields.  Most notably, yields on US Treasuries (particularly the 10 year) have quickly increased as the bond market seems to finally be responding to the stronger than trend economic growth in progress.  This strength, when coupled with unemployment hitting its
lowest rate in 49 years (recent tick 3.7%) is being extrapolated to mean more robust wage growth is on the short horizon, and wage growth is historically the primary driver of broad-based inflation.  And, if inflation is on the rise, it gives the Fed cause to continue on a path of additional rate hikes.  Additional rate hikes compound the fear that the Fed will make a mistake by rising rates too far, too fast, and choke off the economy via more expensive access to money (for both consumers and businesses).  More expensive money, all else equal, will lead to fewer home sales, fewer auto sales, and other big-ticket purchases.  It also means corporations spend more of their financial resources of interest and are less likely to take on debt.  True as that may be, we do not see/read anything that suggest current inflation trends will turn into problematic 70’s style inflation – so the we believe the Fed will not need to further hasten its pace of hikes beyond what they have already telegraphed and remain highly vigilant of the yield curve as an indicator as well.  In any case, this quick upward adjustment to treasury yields is creating an “interest rate hiccup”.  Such hiccups are actually a pretty normal occurrence during more mature stages of economic growth cycles; of course they never feel comfortable.

So what should an investor do when in the midst of such a volatile awakening?  Most important is to refocus on the fundamental inputs to asset prices: the economic backdrop and corporate earnings.

From our perspective, economic fundamentals remain strong – particularly in the US.  The yield curve, while very flat, is not yet inverted (condition which enjoys a perfect track record of leading recession) and consumer and business confidence generally remain high.  Corporate earnings are also up between 20-25% year over year, and 3Q earnings season commencing soon is anticipated to deliver similarly strong results.  The US economy never experienced a recession when corporate earnings were still growing.  Thus, we believe this pullback is most likely a blip; maybe very near its conclusion.  Some may be considering bailing out; but to attempt to sell right now, with an expectation that the drift lower continues significantly deeper and/or longer is a big “IF”.  One pursuing such a strategy could find themselves practicing exactly the opposite – selling relatively low and buying back in after recovery – of what every investor strives to do (buy low and sell high).  We do not advocate pursuit of short-term trading strategies.  Trading is not investing.  History: may not repeat but usually rhymes, reveals that 4Q is ordinarily very positive for investors, especially so in midterm election years like this… and following every midterm election since 1946 the market was positive over the coming 12 months.  That’s powerful food for thought too in considering how much longer this weakness is likely to last.

Often, we discuss with clients the concept of investing money via a “buckets of time” framework.  This means allocating money into the major asset classes (stocks, bonds, cash) based on over what period of time each of those assets required to see risk of selling at a loss reduced to almost zero.  If we’ve correctly budgeted our money/accounts into correctly sized buckets relative to how/when we will need access to money, we do not need to get caught up in short-term market moves because money that may be needed over the next 2-5 years is held not in stocks, but rather in bonds and cash that behave with much less volatility.

Bottom line: contrary to what the financial media and CNBC might otherwise lead the investing public to believe (“ABC” mantra – always be churning), most often the best action for savers is to keep the bigger picture your focus and do nothing.  We are not dismissive of the risks present in the market, and do believe the current bull is quite mature; the reason we are presently dialed-down in terms of portfolio risk exposure and favoring areas that are less expensive and traditionally less economically sensitive.  We hope these thoughts are helpful as you may find yourself alarmed by the abrupt return of volatility in these early October days.

Posted in Blog Post.