Markets remained flat for the week, as investors appear to be taking a breather and are awaiting news before making major moves for now. With the trade deal with China the biggest decision hanging over markets, any announcement could make or break the current rally. The US trade deficit in 2018 posted a decade-high figure of over $600 billion, leaving the question as to whether a meaningful agreement can be reached between the world’s two largest economies. Meanwhile, global data continues to paint a picture of a broad slowdown, with Italy in recession, Chinese growth adjusted downward, and the Organization for Economic Cooperation and Development predicting slower growth from the world’s major economies. Despite fundamentals looking weak, almost every asset class has posted gains for the year, in stark contrast to 2018. Most are pointing to an easing Federal Reserve and efforts by Chinese authorities to stimulate their economy as the main culprits for the risk-on rally.
Bond prices have maintained their gains for the year, with yields pushing lower as concerns over a potential economic slowdown and Fed response providing investors reason to seek safety and possible gains from easing monetary policy. Particularly worrying has been the yield curve inversion seen in the “belly” of the curve, where 6-month, 1-year, and 2-year government bonds are yielding slightly more than an equivalent 5-year bond. Inversion has been a strong predictor of recession, though the lag time between initial inversion and recession is approximately 18 months, with often times equity markets experiencing some of the best gains during that time period. With an already cautious Fed and investors still scarred from 2008, we believe it is likely that a mild recession could occur within the next several years, but that policymakers will be at the ready to intervene, which we believe is reflected in current bond yields.
We’re looking for more direction from markets for now before making any further adjustments to the tactical allocation. Given the lack of conviction on significant moves higher, we believe maintaining a defensive position at this time may be warranted. Though a trade deal with China would provide a much-needed boost in sentiment, it is likely that much of that news is already priced into forward-looking equities. Stock prices appear mostly fairly valued in our view at this time. With that said, the biggest risk we see is not to the upside, but that a bungled trade deal could reverse much of the gains seen since the December plunge. Any significant price appreciation from here could be short-lived, as the decline in volatility is unlikely to remain, in our view. For that reason, we have steadily increased bond exposure and reduced equities, in an effort to maintain the appropriate risk levels within the models. As always, we continue to remain extremely focused on monitoring unfolding market dynamics and reacting only when appropriate. Please feel free to call our office with any questions you may have.