This weekly report presents insights from our Global Investment Management team.
News in the early morning on Tuesday circulated preliminary reports of an explosion in downtown New York that is now being labeled an act of terrorism; fortunately there were no serious injuries.
The act caused speculation that markets could see potential equity volatility with downside pressures. The market initially opened lower as investors digested the magnitude of the failed attack; however, the market deemed this as transitory and within an hour was trading higher to new record levels. Instead, participants looked toward the big decision of the week and into the end of the year, both of which are stacked with direct market-moving events.
The most notable event of the week for financial markets is certainly the Federal Reserve’s last meeting of the year, which came to a close on Wednesday. As expected the Fed came to the decision to raise rates for a third time this year, and the fifth time in eight years of expansion. The market has largely already priced the move into bond and equity markets as optimism and positive economic statistics embolden Fed governors. The most recent report of the Producer Price Index, released by the Bureau of Labor Statistics on Tuesday, showed a higher than expected increase and at the fastest rate of growth since January 2012. The report assesses the average change over time in the selling prices received by domestic producers for their output, essentially measuring a form of inflation for products and services. Even the most dovish of decision makers would agree that a rate increase would be prudent given the current data.
Over the last month, the yield curve has responded with short-term rates moving up in anticipation of the hike, while the long end has moved down creating a bear-flattening movement for the Treasury curve. With the bond market viewed as an indicator of future economic health, some warning bells are starting to ring. Inversion of the curve is generally an early predictor of an impending recessionary environment, although it should not be considered completely reliable as this forecasting tool has failed before. When looking at an impetus for the market to trade off and correct, this could be an event which would certainly raise the hairs on investors’ arms.
The counterargument for a gradual increase in the long end of the curve is a strong one, especially following the report mentioned earlier. A rise in prices should move the inflation premium upward along with nominal rates, but combined with the Fed’s hikes could create a potential double whammy situation. The unwinding of the balance sheet should decrease artificial demand, which would raise rates to some degree along the curve dependent upon the supply from the Treasury and demand from global sources. We continue to focus on select sectors of the bond markets, which has resulted in near-benchmark duration in our fixed income strategies. This means that we are in the belly of the curve and continue to allocate to sectors that will help protect principal given both the short and longer-term aspects of the Treasury market.
The movement by the Fed continues to be shrugged off by the equity markets as stocks extend their rally and continually break new records. The prolonged economic expansion and coinciding bull market we have experienced have been largely due to extremely easy monetary policy, the expectation of stimulus from fiscal measures, and a gradual improvement in the consumer and business environment. Due to these boons, we are slowly grinding closer to overtaking the longest expansion that occurred from the 1991 to 2001. When looking back at historic runs and where we are at now, we are arguably in a better position to see further growth. We have not seen an overheating in inflation, employment remains low while the consumer continues to be resilient, and business investment has started to pick up. With that said, risks from geopolitical pressures, a tax bill as well as a government shutdown percolating at the end of the year, and further uncertainty and discord throughout our own country, risks still abound that could reverse sentiment and confidence. For now, taking some profits over the year has been prudent as we move through the later stages of the economic cycle.
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Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
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