November Market Overview
After a rough October, the news was better in November. Stocks rebounded a bit in the U.S., while bonds were also up modestly.
December, however, has gotten off to a rough start with market volatility: oil declined, the yield curve flattened (in some spots inverted), and credit spreads widened out a bit. The market clearly believes the Fed is going to have to slow down, as bets on the direction of future interest rate increases show much lower probabilities of rate hikes in 2019. The Fed, from what we can surmise from public comments, seems to be getting the message.
There is a lot of talk about the flatness of the curve and whether inversion means recession is right around the corner. The St. Louis Fed has put out thoughts on the matter, and their take is that a flat or inverted curve doesn’t mean a recession is imminent, but it does leave the economy more exposed to potential shocks so that if we get a shock, it could tip the economy into recession.
Our take is that there aren’t many clear excesses in the system, but there are some areas of concern. One is the state of housing: With interest rates on the 30-year mortgage rising to 5%, this impacts affordability and prices with various knock-on effects. Another concern is the sheer amount of corporate credit. Companies rated BBB (one notch above investment-grade) hold almost the majority of corporate credit, and we could use a deleveraging cycle. This would reduce merger activity and financial engineering, so it could be a little bit of a slog, and some of these issuers may be ill prepared for a turn in the economy when it inevitably comes. It could be tough sledding for a bit, but these things are healthy, and we think our longer-term expectations are still reasonable.
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