The 3rd Quarter of 2019 was almost a copy of the 2nd, only slightly less so. Both had bad months (August and May) sandwiched in between a couple of good months. However, May was worse than August, and the sandwich months weren’t quite as strong in 3Q as they were in 2Q.
For all the promise of volatility at the beginning of the year, 2019 has been surprisingly calm, or reasonably so. Why? Not much has fundamentally changed.
In fact, all of our favorite bricks in the wall of worry are still there. These are, in no particular order: 1) slowing global economic growth; 2) trade wars with China (and presumably everyone else at some point); 3) Brexit; 4) polarizing US politics; 5) flattening of the US Treasury yield curve, and; 6) the future of US monetary policy.
All in all, the biggest difference between the last four quarters has been the markets’ outlook for future Fed policy.
- During the 4th Quarter of 2018, investors were anticipating future rate hikes.
- During the 1st Quarter of 2019, the markets thought the Fed was ‘on hold.’
- During the 2nd Quarter of 2019, the Street began to ‘price in’ several rate cuts by the end of the year.
- During the 3rd Quarter of 2019, investors didn’t quite what to think about the Fed. All they knew for certain was the future of US monetary policy was probably easier, even if not all the economic data supported it.
Interestingly, the economic data doesn’t suggest the need for easier money in the US. The economy has continued to grow a modest, arguably sustainable pace. Even so, the dreaded word ‘recession’ has reared its ugly head, without any support from the economic data. So, what gives?
What gives is interest rates have fallen sharply over the last 12 months, despite continued growth. It is kind of unusual to see the long-end of the yield curve fall significantly without: 1) a commensurate decrease in economic activity, and/or; 2) a significant change in future inflation expectations. To be sure, both have fallen slightly. However, the decrease in rates has been greater than the situation would normally allow.
Regardless, the Fed can’t afford to be cavalier about a sharp decline in longer-term interest rates leading to an inverted or substantially flat yield curve. While an inverted yield curve doesn’t always mean a recession, recessions always have an inverted yield curve. So, who is right? The stock market which is saying good times are still ahead or the bond market seems to be suggesting the opposite?
At this time, Oakworth’s Investment Committee continues to believe US stocks offer the best potential for both absolute and relative return moving forward. Until there is a clear, established trend otherwise, we believe the US economy should continue to expand at a modest pace. Further, despite rate cuts by the Federal Reserve, the US dollar remains the strongest reserve currency. Whew.
It should be an interesting end to the year.