Special Release - Beware the Ides of … August?

August 19, 2019

In our most recent quarterly letter, we discussed how the global economy was still growing despite several macro headwinds. Since August 1st, when President Trump announced additional tariffs on $300 billion of Chinese goods, investors have been deluged with news of disappointing economic data, currency manipulation, and yield curve inversion. As a result, growth concerns are back and weighing on risk sentiment, which is causing a spike in volatility for equity markets.

Recent economic data indicates that certain international economies are slowing more than originally forecast. Germany and the U.K. reported second quarter GDP numbers that implied their economies were contracting slightly. The disappointing data has not been limited to Europe. The U.S. and China also released data that missed expectations, though importantly, still indicated economic growth.

Also shaking investor confidence is the continued drop in global sovereign bond yields. Globally, $15 trillion in bonds are trading with a negative yield. Examining the treasury yield curve, the all-important ten-year/two-year spread inverted this week, albeit very briefly. An inverted yield curve has historically been an indication that a recession could happen, though not imminent. Historical patterns suggest that, if a recession does occur following the inversion of the yield curve, it normally happens within the next 12-to-24 months.

The news has not been all negative. This week, over half of the additional tariffs announced on August 1st were delayed until December so that they would not negatively impact the holiday season. Meanwhile, the strength of the job market and rising wages continue to support the U.S. consumer, the driving force of the U.S. economy. The Federal Reserve and other central banks have also reengaged and are adjusting monetary policy to be more accommodative. While not a panacea, we believe it is a welcome sign.

It is important to not overreact to how equities behave on any one day, especially in August. August is known for light volume since many trading desks are lightly staffed. This makes the market susceptible to the impact of computer-driven trading programs, which can exaggerate short-term market moves.

As stated in our most recent quarterly letter, we remain cautiously optimistic. Though optimistic, we plan to continue reducing equity exposure to a “neutral” stance relative to each clients’ equity target allocation. Tactically, cash balances are likely to rise while we wait for opportunities to redeploy. Meanwhile, our bond holdings are performing well in this falling interest rate environment and continue to offer a ballast against higher equity volatility.

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