Yesterday, the tech stocks got hit hard on news that Washington will be taking a much harder look at regulating them. Trade worries continue to reverberate throughout the market. And fears of a more severe slowdown—or even a recession—are building as the yield curve remains inverted. Further, the Nasdaq moved into correction territory yesterday (defined as a decline of more than 10 percent from the peak), although as of this writing, it was showing signs of a strong bounce today.
Given such turbulence, we find ourselves pondering that familiar question: is it time to panic? Once again, the answer is “not yet.” Although the worries are real, the foundation is solid. Let’s take a closer look.
Economy still growing
Economic growth drives market returns. As long as the economy is growing, marketstend to do well. In fact, although there can be sharp corrections during expansions, they are usually short. We have seen this scenario with the pullbacks in 2011, 2015–2016, and 2018, where corrections were sharp but reversed quickly. Sustained bear markets (e.g.,
2000 or 2008), on the other hand, occurred when the economy went into recession. As long as we don’t have a recession, markets should recover from recent weakness.
So, is a recession on the horizon?
At some point, we will have a recession. But the signs indicate that it won’t be soon. We have never had a recession with hiring and consumer confidence as strong as they are right now, for example. Although we did see a pullback in both, we have since had a recovery—which is positive. With consumer spending making up more than two-thirds of the economy, it is hard to get a recession when both hiring and consumer confidence are solid.
What about the yield curve?
Historically, when the yield curve has inverted, a recession has occurred in the following 8 to 18 months. That clock may have just started. In theory, then, we could have a recession early next year. Before that, though, hiring and confidence would have to decline (see the previous paragraph). The yield curve is something to watch but is not an immediate problem.
Trade war affecting confidence
The weakness in business confidence and investment is concerning. But this worry is one based largely around the expanding trade war. Despite that, both sentiment and investment remain positive. Further, although we do see some weakening, there has not been a decline. Right now, that weakness would not be enough to take the economy down.
The economy is like an oil tanker: it moves and turns slowly. Markets are like speedboats, orbiting around the tanker. They move faster and can certainly rock more on the waves, but they follow the big boat. As long as the tanker is moving forward, so do markets.
Right now, the economy is still moving forward, which should continue to support markets. Much of the recent turbulence has come from the news, especially around trade, which has affected confidence. Lower confidence—and more uncertainty—is bad for markets and explains what we have seen recently.
Confidence can improve as quickly as it deteriorates, however, and we have seen that several times during the recovery. The most likely case is that confidence will improve again, as growth continues, albeit at a slower pace. Even if we do see more slowing and a pending recession, we will still have time to plan our next steps.
Are you comfortable with your risk?
And that is what we should be doing: keeping an eye on the economy, the markets, and our portfolios. The real lesson of the recent volatility is that we need to be comfortable with the risks we are taking. If not, we should take steps to ensure that we are comfortable.
After all, at some point we will see a recession and a bear market and will have to ride them out. As such, we must be prepared for when they happen. It just doesn’t look like that will be in the immediate future.
Authored by Brad McMillan, CFA®, CAIA, MAI, managing principal, chief investment officer, at Commonwealth Financial Network®.
© 2019 Commonwealth Financial Network®
Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.