I’ve been told that Hot Air Balloon rides are great fun! I will never know because I am terrified of heights and would never dream of getting on board. Oh sure, they float along blissfully when there is plenty of hot air, like a rising stock market, but what happens when the air gets cold?
With economic growth slowing around the world, the air in the balloon may be starting to cool down a bit. Going back to last year, most everyone believed the air going into the balloon was red hot and that economic growth was going to keep rising. Fast forward 12 months and we are starting to see more signs that challenges to economic growth, and our steady supply of hot air, are growing.
- The Organization for Economic Co-operation and Development (OECD) is an intergovernmental economic organization with 36 member countries. The OECD’s Composite Leading Indicator for the United States just fell another notch and is now at its lowest level since November 2009.
- Corporate earnings are expected to decline in the current reporting period.
- Small business confidence fell in September and has declined in three of the last four months.
- The Producer Price Index (a measure of inflation pressure) declined in September when analysts were expecting a modest gain.
- Political issues and global trade concerns persist.
The chart above compares the 10-year US Treasury rate in blue with the Institute for Supply Management (ISM) Manufacturing Production Index in orange and the ISM Services Index in red. The ISM runs a monthly survey of both manufacturing and service sector activity. Historically, any reading over 50 is considered expansionary, while readings under 50 indicate contraction. What you will notice from this chart is that the interest rate on the 10-year treasury bond rate has moved lower with both the services and manufacturing indices since the end of 2018, with the recent print on the manufacturing index below 50, indicating contraction.
Why Do We Care?
Certainly, this information does not mean a recession is upon us, but it’s hard to look at the trend of these indicators and not wonder if this is a pause that refreshes or if the air in our balloon is cooling off. As mentioned earlier, we have come a long way since last fall when all signs pointed up. The markets have generally done well during the first part of 2019, but have started to level off this summer as growth has come into question. The consensus view now is that the Federal Reserve will cut rates at least one more time in 2019, leaving the door open for more if growth continues to sputter. That door will swing wide open if we continue to see a US/China trade stalemate and/or an increasing frequency of hard economic data points like the recent ISM surveys.
In March last year, we decreased the duration of our bond portfolio to help defend against the risk of rising interest rates. As a quick refresher, bond prices and interest rates move in opposite directions (bond prices go down when interest rates go up and vice versa). The degree to which they move is referred to as “duration”. If rates are going up/down, the more duration one has in a portfolio, the more prices will move. So, an investor wants less duration when rates are rising (prices falling) and more when rates are falling (prices rising). Our tactical decision to reduce duration remained in place for most of 2018 as rates climbed to a high point in October. Since then, we have slowly reversed course by lengthening the duration of our bond holdings. Based on our current observations around economic growth, and the likelihood of additional interest rate-cuts by the FED, HCM has made the decision to eliminate our remaining short-duration holdings and increase the average term of our bond portfolio.
While this will add additional price volatility to our fixed income portfolio, our concern around rates moving higher has diminished over the past several weeks as signs of economic growth are fewer and further between. Benefits to increasing our portfolio’s duration include providing a natural hedge against equity volatility, should stocks fall, while providing a slight increase in portfolio’s interest income. We also want to emphasize this isn’t a call for recession or a bear market. This market has been characterized by fast moving, but ultimately fleeting, narratives that have caused stock prices to experience range-bound volatility.
Other than one change in our Dividend Growth Portfolio™, HCM has made no recent changes in our equity allocations. All portfolios remain neutral relative to their assigned risk targets with a bias to large U.S. securities. We continue to monitor our technical indicators for signs that a risk reduction is in order. And while a few have flashed a warning, we have not seen the pervasive action that would call us to action.
Recognizing that we manage assets that are critical to your long-term financial independence, rest assured that we will not hesitate to act to protect your capital when the warning signs appear.
Weekly Focus – Think About It
“Commitment leads to action. Action brings your dream closer.”
Performance last week for the four major asset classes were:
- U.S. Stocks – Russell 3000 (IWV) – Loss of -.36%
- Developed Foreign Markets (EFA) – Loss of -1.23%
- Emerging Markets (EEM) – Gain of .81%
- Fixed Income (AGG) – Gain of .83%
(Note: performance is based on the change in price plus dividends)
Last Week’s Headlines
- US and China trade talks are slated to resume, as the China delegation returns to the US with the small possibility of a truce and agreement of a comprehensive trade deal unlikely.
Eye on the Week Ahead
- US CPI is expected to come in around or slightly above the Fed’s target of 2%, while the University of Michigan Consumer Sentiment Index will provide a signpost of whether a strong consumer can continue to offset manufacturing weakness.
If you have questions about the recent market conditions, please contact a member of HCM’s Wealth Advisory Team:
Any tax or other advice contained in this document, including any attachments, is not intended and cannot be used for the purpose of avoiding penalties under Internal Revenue Code. No action should be taken on any information contained in this message without first consulting with your tax/legal advisors regarding the tax/legal consequences for your particular circumstances.
- The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.
- Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
- Past performance does not guarantee future results.
- You cannot invest directly in an index.
- Consult your financial professional before making any investment decisions.
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