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As we start the month, there are lots of things in the headlines. Impeachment, coronavirus, Brexit, and the uncertainty reflected in the ~3% decline in the S&P 500 in the last 8 trading days of January. Regarding the economy, leading indicators are signaling that the risk of recession in the near term is receding. Manufacturing posted its first gain in 6 months for the month of January and confidence appears to be strong, given that new orders rose by the most in the past 6 months. It appears that our thesis of slowing, but continuing growth instead of a recession is playing out. We expect continued but muted economic growth throughout the year. While the coronavirus is an issue for the Chinese economy, we do not expect it to heavily impact ours. Brexit remains a wild card, but may play to our benefit as we have some trade disputes simmering with the EU and their energies appear more focused on containing the fallout.
The S&P 500 had a pullback of ~3% at the end of January, which has been reported to be driven by fears related to the coronavirus. That may well be the headline risk at the moment, but volatility measures are elevated, and profit expectations are lower for the year. Stocks are trading near all-time highs, but seem to have no apparent reason for them to trade higher (such as higher profit expectations). Conversely, signals that indicate stabilizing geopolitical and economic outlooks (at least as regards the United States) argue for a floor under the markets as well. As such, choppy range bound markets are expected for some time, at least until a new catalyst emerges.
The 10-year Treasury is currently yielding 1.53%. There are numerous potential causes for lower rates, including a desire for the safety of Treasuries due to the many headline risks in the current environment. We also think that we are, to an extent, importing some of the deflationary pressure from the EU and Asia, where some areas are offering negative yields. In the same way that the equity market has the VIX Index to measure volatility expectations, US Treasury volatility is measured by the MOVE index. This is elevated and signals that rates may become volatile. While we don’t know when yields will begin to rise, we are confident that they will. As the risk of recession recedes, and economic and profit expectations begin to climb, it is natural that rates will begin to move higher. And if wage inflation begins to be a concern, it is likely that inflation expectations, and rates could move higher more quickly than most market participants expect. We are watching for this, and continue to have a bias for shorter duration, high quality corporate bonds.
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