Is a recession in the U.S. around the bend? Few economists are predicting one.
On the other hand, longer-term Treasury bond yields continue to slide below shorter-term maturities. Bond investors are gobbling up long-term government debt because they believe that the economy will slow dramatically.
Normally, the longer an investor allows the U.S. government to keep capital, the more that an investor would expect in annual interest from Uncle Sam. That is what transpires in a healthy economy.
This past Friday, however, the yield on the 10-year Treasury bond fell below the 3-month bond. The last time this occurred? Shortly before the Great Recession in 2007.
There are implications of the yield curve inversion. Most notably, the bond market will eventually force the Federal Reserve to cut its overnight lending rate to stimulate the economy. The current 2.25%-2.50% range may soon work its way back down to the zero bound.
In direct opposition to bond market fears, the stock market has been remarkably optimistic since the Fed flip-flopped on monetary policy. In December, the central bank had been telegraphing 2-3 rate hikes to get the overnight Fed Funds lending rate to a “neutral level” of roughly 3.0%. Today? Current committee members agree that there will be no rate hikes for 2019, while a future prospective participant is calling for an immediate cut of 50 basis points.
There’s more. Back in December, quantitative tightening (QT) had been set on a course to continue into 2021. More recently? Monetary policy leaders have decided to terminate balance sheet reduction by September of 2019.
Not so long ago, Fed officials insisted that quantitative easing (QE) was not a mechanism for printing money electronically. As long as the Fed eventually retired the electronic money credits it used to acquire assets like U.S. Treasuries, the claim carried some validity.
Now, however, the Fed will return to the reinvestment of electronic credits used to buy Treasuries (September). At best, the balance sheet will remain on a permanent plateau; at worst, more QE will send the balance sheet into the atmosphere. In either case, the permanence of electronically created trillions is the essence of money printing.
For the time being, though, stock investors believe that the Fed can protect the U.S. economy from falling into an abyss. And by some measures, they may have it right.
Consider the recent Conference Board Consumer Confidence results. Granted, the Present Situation Index fell 7.1% from last month. That’s hardly a stable sign. On the other hand, the Future Expectations Index only slid 3.8%.
Typically, when expectations about the future of economic prospects are dropping at a faster pace than the present-day assessment, there is good reason to be concerned about a self-fulfilling prophecy. Instead, people are more aware that the present-day circumstances have slowed considerably, yet the future may not be so dire.
A deeper dive into to Consumer Confidence data is less rosy when it comes to the employment picture. In particular, the Labor Differential (Jobs Plentiful – Jobs Hard to Get) plummeted 17.5% in March (from February). That represented the largest drop in a decade.
Most tend to agree that the real trouble is global. Global transporter Federal Express, for instance, recently reported abysmal revenue and earnings; guidance for the future had been even more devastating. In fact, the company intends to slim down its workforce via hiring constraints and a “voluntary employee buyout program.”
In a similar vein, economic numbers across Europe, especially Germany, continue to disappoint. German manufacturing contracted for a 3rd consecutive month, sending its 10-year yield into negative territory.
Perhaps one can look to the global manufacturing contraction and earnings recession (2015-2016) for comfort. The U.S. economy endured the global headwinds with ever-lower bond yields and 22 months of sideways stock market activity.
Will 2019 provide similar opportunity for equity enthusiasts? Hard to imagine.
For one thing, foreign central banks in 2016 had implemented QE programs that dwarfed prior monetary stimulus programs. For another, the November 2016 election served up the promise of dramatic fiscal policy stimulus via corporate tax reform. Here in 2019, significant Fed stimulus with additional QE is not likely to be introduced until and unless the stock market falls into true bearish despair.
True bearish results are hardly out of the question. Not only have the major averages yet to reclaim former 2018 glory, but financial stocks are noticeable non-performers. The SPDR Select Sector Financial SPDR (XLF) is 14% off of highs set back in January of 2018.
Here is where the rubber may be hitting the proverbial pavement. When demand for longer-term Treasuries far exceeds shorter-term maturities, banks are less capable of lending profitably. The possibility exists for a credit squeeze (a.k.a. “credit crunch”) that hinders consumer spending as well as business activity. It may not matter how favorable rates are if the lenders stop lending altogether.
Granted, a credit squeeze is not preordained. Neither is a 2019 recession.
Nevertheless, recent peaks for employment, the ubiquitous use of leverage as well as asset price records (e.g., stocks, real estate, etc.) may collectively suggest that we are nearing an end to the business cycle. It is unlikely to be indicative of a brand new start.
Is it possible that monetary policy folks can keep pulling rabbits out of their bag of tricks? We may not want to bet against them. That said, lenders may avoid taking on additional credit risk and businesses may rein in their bloated debt piles.
Nonfinancial corporate debt as share of GDP has rocketed higher before each of the past three recessions, only to descend precipitously in the throes of economic contraction. It follows that you may prefer to leave the party early rather than overstay your welcome.
My retiree and near-retiree clients are underweight their highest stock targets. We would require a breakdown in technicals (e.g., slope of the 10-month SMA, price of the 10-month SMA, NYSE A/D Line, etc.) to further reduce our exposure.
We continue to maintain a healthy level of high quality “preferreds,” other rate sensitive assets as well as defensive securities in health care and consumer staples. We won’t be shorting the market in an effort to beat the bear drum; rather, we’ll be looking to lose significantly less to weather the storm. That is the way we recovered quickly from the 2000-2002 tech wreck and the 2008-2009 financial collapse.
Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.
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