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“The market climbs a wall of worry,” is an old piece of Wall Street wisdom. And we have had plenty to worry about in 2019, including: trade wars, political intrigue with serious concerns on each side of the aisle, a slowing economy, Brexit, and serious social unrest in multiple emerging markets.
The US Economy’s most recent GDP measurement came in at an anemic 1.9% against consensus expectations for an even lower 1.6%. The report was widely played up in the media, but a deeper reading reveals some concerns. While consumer spending has held up remarkably well, business investment has pulled back, in part due to problems in international trade. What’s to worry about here? Business investment is the foundation for future growth, and with a reduction here, the durability of consumer spending over time is in significant doubt. Said another way, without investment, can the economy continue to deliver the strong labor market that drives spending? According to the NY Fed, there is an approximately 35% chance of an economic pullback within the next 12 to 18 months. If the consumer can hold up and the drop in business investment is temporary, we see decelerating, yet still-positive economic growth, instead of recession.
Against this backdrop, the S&P 500 Total Return Index, which includes dividends, ended October with a 23.16% year to date return, with a popular measure of risk expectations at very low levels (VIX Index, 12.61, the lowest level since April). We are maintaining a cautious stance in our composite, which despite the broader market marching to new highs has outperformed the benchmarks, year to date.
Currently, 2-month Bills yield more than 5-year Treasuries. The oft-discussed 2-10 spread, which has been inverted for a significant portion of the year, is no longer inverted. This could indicate that economic stress is receding, but that is not a definitive indication. What is more interesting is the change in shape of the yield curve overall in the past month. The short end (within 5 years) has largely flattened and rates are actually moving up at a 7-year inflection point. In other words, it appears that something is supporting higher long-term rates. That something could be the beginnings of expectations that current loose monetary policy is going to reflate the economy, but the changing shape could also auger increasing risk. We are paying close attention because the former is a positive outcome, the latter, not
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