“What, me worry?”- Alfred E. Neuman, fictional character of Mad magazine, which, after 67 years, just announced it will no longer publish new issues
Maybe the question should be why aren’t we more worried? Investment performance in both U.S. stock and bond markets has been strong year-to-date and while some investors are concerned about a sell-off, others are worried: worried about a possible recession, worried about interest rates, uncertain about growth. They’re also worried about missing out on the next big thing, worried about “beating the markets” and perhaps not worrying enough about the risks of their investments. Consider that:
The yield curve remains inverted – a condition that is famous for being an accurate predictor of recessions.
The Federal Reserve has done a “complete 180” in the last 9 months, going from rate increases, to neutral, to all but guaranteeing a rate cut this month.
International trade tensions remain heightened and could create potential uncertainty for business activity and earnings (see next point).
The U.S. Manufacturing Purchasing Managers Index (PMI) reading has been declining and hit 50.1 in June – it’s lowest reading since September 2009. A reading below 50 indicates contraction in business manufacturing activity.
The S&P 500 gained over 18% in the first six months of 2019, which would have been better than more than half of the annual returns since 1926.
Much of this year’s strong performance has been a reversion from a very rough 4Q18. Below the waterline of positive performance in 2019, markets experienced a significant decline in May, value-oriented and small cap equities, while positive, are still trailing large cap and growth stocks, and international equities are facing pressures due to trade, tariffs, and growth concerns.
The S&P 500 was up 4.3% in the second quarter and is now up 18.5% year-to-date in 2019. It is easy to forget that there has been a tremendous amount of volatility in stock market performance over the last 12 months.
Smaller-cap stocks, as represented by the Russell 2000 Index, were up 2.1% in the second quarter, and while up 17% year-to-date, they have lagged larger-cap equities.
The yield on the 10-year U.S. Treasury has fallen nearly a full percentage point over the last 12 months to end the quarter at 2.0%. As a result, the Barclays aggregate bond index was up 6.1% year-to-date, amid a “flight to safety”.
International equities (MSCI EAFE Index), including emerging markets (MSCI EM Emerging Markets Index), rebounded in the second quarter but are still trailing U.S. market (S&P 500 Index) performance year-to-date.
Data Ending 6/30/2019 (not annualized if less than 1 year)
|Equities Indices||Q2 2019||YTD||1 year||3 years||5 years||10 years|
|MSCI ACWI (All Country World)||3.8%||16.6%||6.3%||12.2%||6.7%||10.7%|
|S&P 500 (U.S. Large Cap)||4.3%||18.5%||10.4%||14.2%||10.7%||14.7%|
|Russell 2000 (U.S. Small Cap)||2.1%||17.0%||-3.3%||12.3%||7.1%||13.5%|
|MSCI EAFE (International Developed)||4.0%||14.5%||1.6%||9.7%||2.7%||7.4%|
|MSCI EM Emerging Markets (International Emerging)||0.7%||10.8%||1.6%||11.1%||2.9%||6.2%|
|Fixed Income Indices|
|FTSE World Government Bond Hedged (Global Bonds)||3.1%||5.9%||7.8%||2.6%||4.0%||3.9%|
|Barclays U.S. Aggregate (U.S. Investment Grade Bonds)||3.1%||6.1%||7.9%||2.3%||3.0%||3.9%|
|Barclays Municipal Bond 5Y (4 – 6) (Municipal Bonds)||1.7%||3.8%||5.2%||2.0%||2.3%||3.2%|
|Barclays U.S. Corporate High Yield (U.S. High Yield)||2.5%||9.9%||7.5%||7.5%||4.7%||9.2%|
|S&P Developed REIT (Global Real Estate)||1.5%||16.3%||10.3%||4.7%||6.7%||13.6%|
|HFRI FOF: Conservative Index (Diversifiers)||1.6%||4.9%||2.3%||3.9%||2.2%||3.1%|
Source: Zephyr Analytics & Morningstar
Are We Headed Toward a Recession?
Everyone today is desperate to know how and when this economic boom cycle will end. It is important to remember that both stock and bond markets are forward-looking and do not march in lock-step with a “recession.” The equity declines during 4Q18 seemingly demonstrated this concern and may have accurately predicted the recent decline in the manufacturing PMI data. Is this data recessionary in nature? It is hard to know whether the recent stock market gains are forecasting a rebound in economic activity or if the gains are a false-positive.
“It’s a recession when your neighbor loses his job; it’s a depression when you lose yours.” – Harry S. Truman
While President Truman offered his definition of a recession, the textbook definition is much drier and harder to understand. A recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters. In reality, economic slowdowns can take many forms and be caused by a variety of issues — including pullbacks by either consumers or businesses (or both), geopolitical or international problems, governmental policy errors, and even wars — and each can have different implications for your investments.
Who Determines a Recession
The National Bureau of Economic Research (NBER) is well known for providing start and end dates for recessions in the United States. NBER is a private nonprofit research organization “committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic community.”
Even if the U.S. economy is slowing, few know the exact path or timing. Even the NBER can be slow to label a recession. For example, NBER notes that the 2007-2009 US recession started in December 2007 and ended in June 2009. The trouble is that NBER made its “recession call” in December 2008, a full 12 months AFTER they said it started. Between the start date and the announcement date, the S&P 500 had declined 39%. I think most of us knew we were in a recession then and didn’t need the NBER to tell us.
What happened AFTER the announcement until the recession ended is telling as well. Even though the recession ended in June 2009, the “official announcement came in September 2010. In investment terms, between the announcement of the recession start in December 2008 and its end in September 2010, the S&P 500 gained nearly 28%. If there is any evidence about why it is hard to time markets, these announcements are it.
We started out this Perspectives with a fair amount of pessimism, mentioning slowdowns, concerns about growth, economic tensions and market volatility. We prefer a glass half full than one half empty. While we may indeed see GDP growth slow in the coming quarters, a textbook recession seems less likely in the near term given the following facts that we know today:
The U.S. unemployment rate is as low as its been in 50 years.
Ongoing trade talks could result in a more benign international trade environment for world business than currently feared.
We are entering an election year of a first-term president seeking reelection, who is likely to do everything within his power to ensure a recession does not occur on his watch.
Harry Truman’s words remind us that a recession can mean different things to different people, and the steps that lead to a recession and the time to recovery are often unpredictable and different with each economic cycle.
So, what to do? Plato wrote “courage is knowing what not to fear.” Investors shouldn’t have to fear slowdowns, because there are tremendous opportunities that can arise from those moments. We at Modera don’t try to time your investments based on the economic cycle or recent investment performance. Instead, we focus on your personalized and comprehensive investment strategy with your own financial objectives and time frame for determining the proper asset allocation and cash management strategy that we believe best suits your specific needs.
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The returns shown in table 1 are annualized returns, except for periods less than one year, for selected asset classes as represented by benchmark indices. Investors cannot invest directly in an index. Unmanaged indices do not reflect management fees or transaction costs associated with some investments. Past performance is no guarantee of future results, and there is no guarantee that the views and opinions expressed herein will come to pass. This document contains forward-looking statements that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. Readers are cautioned not to place undue reliance on forward looking statements, which speak only as of the date of this document.
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S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2018, all rights reserved. Bloomberg Barclays data provided by Bloomberg.