Volatility

April 25, 2018

 

This month we have continued to see market volitility.  The causes have varied.  First, there was the back and forth tariff squabble between the U.S. and China.  This caused investors to worry about a potential trade war between the world’s two largest economies that could even spill over and affect the rest of the world.  These fears subsided with the rumors of talks by the two countries’ leaders about containing the spread of increased tariffs.  The tariffs that have been implemented thus far would only have a slight, weakening effect on the U.S, China, and the world economy.  Also, world leaders recognize that there are no winners in a large trade war.  These talks decrease the likelihood that this trade conflict will intensify to a point that would seriously affect the world economy.

 

More recently investors have been rattled by the fear of an inverted yield curve.  The yield curve is often tracked as a measure of the sentiment about the economy’s overall health.    The yield curve is inverted when the yield on the 10 year Treasury note becomes lower than the yield on the 2 year Treasury note.  This indicates that investors are losing their appetite for risk and are buying long-term treasuries to protect their wealth.  All recessions since 1960 have been preceded by an inverted yield curve.  Currently, the yield curve is not inverted it was just flattening.  The long-term yield was getting closer to the 2 year yield. Also, this does not mean the yield curve will become inverted, and the stock market will decline either.  For example, the yield curve was relatively flat during the 1994-2000 period, the greatest stock market run in history. 

 

Over the last few days we have seen the opposite happen. The 10 year treasury yield has increased, which has steepened or increased the spread between the  10 year treasury yield and the 2 year treasury yield. This increase in the 10 year yield could be a sign that inflation is on the way which may increase the likelihood that the Federal Reserve will increase their short-term rate this year 4 times instead of 3. This would make doing business for large companies more expensive, thus hurting their bottom line. We feel this is a possibility. However, with the U.S. economy doing very well, along with low unemployment, large companies reporting strong earnings, and projecting those earnings to increase in coming quarters (in part due to the somewhat recent tax law change), there is a good chance the world equity markets could still have a good year, even if this continues.

 

 

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