The 2019 rally took a breather this week, as investors cooled to a slew of bad headline risks and the endless rise higher breached some key technical levels. While over the weekend the planned tariff increase with China was put on hold, several negative blowups during the week weighed on investors, with India and Pakistan reigniting nuclear conflict fears, China growth figures stalling, and an abrupt end to the denuclearization talks with North Korea adding to headwinds.
The Federal Reserve provided additional insights into their outlook in Congressional hearings this week, with revelations that the timeline of an end to their balance sheet reduction may be sooner than originally forecasted, helping soothe markets. Chairman Powell continued to emphasize the strength of the US economy while also pointing out the serious risks faced from a global growth slowdown, increasing debt loads by both corporations and governments, and remaining unknowns such as Brexit and the China-US trade dispute. Investors continue to find solace in the more relaxed Fed stance, reinforcing the belief that policymakers will take whatever steps are necessary to prevent a new crisis.
Meanwhile, bond investors appear to be signaling that the growth slowdown will continue, and that the risks of a recession are increasing by the day. The yield curve has relentlessly continued to flatten, with the spread between long-term and short-term bonds becoming smaller by the day. In some parts of the curve, an inversion has already occurred, where short term bonds are yielding more than longer-term Treasuries, in a prediction the Fed will be forced to lower rates in the next few years in response to a recession. In the near-term, however, some signs of a soft landing are starting to appear, with home sales picking back up, and a surprisingly strong delayed report on 4th quarter GDP estimates. The mixed signals are causing investors to take pause, looking for a new catalyst to push risk-on sentiment higher.
As of this time, we have not made significant changes to the allocations since the recent rebalancing, as we believe we are well positioned for what we anticipate to be a rocky year ahead. As noted previously, we have increased the overall quality of the equities in portfolios, with an emphasis on downside protection after a strong rally into the year. With global growth now questionable, the Fed in tumult over its next moves, and rising geopolitical risks, now seems to be a prudent time to de-risk in the 10th year of the current bull market. With signs starting to emerge of a possible recession in coming months or years, we prefer to be more cautious and potentially miss out some upside than be overzealous and caught in a sudden downdraft.