Market Strategy 3/25/2019

• Investors this week will have a broad array of factors to consider in determining market performance in the week ahead.
• Consideration of the recent inversion of the yield curve, progress (or lack thereof) in trade talks, along with anticipation of Q1 earning season in the weeks ahead likely to drive equity and bond market activity this week.
• Economic data that crossed the transom last week underscored resilience in the US economy.
• Even as the broad index declined last week significant dispersion existed within sector performance distinguishing between areas of confidence and concern.

From worries about growth that earlier was said to be too hot for Fed policy to remain accommodative without generating untoward levels of inflation to predictions that the Fed might be too hawkish for a slow growth economy and next stressing about the latest visit of a yield curve inversion traders’ and investors’ attention last week was drawn to the dark side.

We'd suggest that with bullish and bearish market participants having had their share of drama over the past six months it likely will prove best to remain focused on the fundamentals—economic and corporate—and not get too caught up in the drama of the moment as exciting and enticing as some might suggest it is.

After reaching a level just under 2.5% from its 2018 high the S&P 500 stumbled last week accompanied by a wide and diverse group of other equity benchmarks stateside and international.

Trade war and growth worries took center stage last week as equities slipped from their high perch and bond yields fell—sending the US 10-year Treasury yield from 2.75% at the beginning of March to 2.44% last Friday. Bears who have felt little joy for most of the first quarter as stocks moved higher in nine of the last 12 weeks through last Friday started to smile again last week and skeptics looked about ready to say “I told you so!”

The UK’s Brexit troubles and a set of weak data on the European economic front added to a scene where the FOMO (fear of missing out) crowd turned into the “run for the exit” crowd.

short-term focus had bears hanging their hats last week on an inversion of the yield curve that surfaced (again) with considerable fanfare. A lapse in short-term memory appeared to erase for some observers an inversion which had occurred between the 2-year and the 5-year US Treasury’s yield last quarter that also raised considerable fanfare and predictions of a recession looming around the corner. This time in contrast to last quarter’s inversion the duck under in yields occurred on another spot of the yield curve but nobody seemed to notice that last week.

It would appear to us that the latest occurrence of an inversion in the yield curve suggests concern that indeed a failure to arrive at a resolution to the trade war might increase the chances of a recession stateside and elsewhere 12 months ahead.

That said if an agreement with China is arrived at (rather than a continuation or acceleration of trade hostilities between the US and China), we’d expect to see a quick and upward revision of growth expectations for the stateside and international economies.

We find it too early to call the outcome of the trade war in either direction and expect so do many other investors. Hence the inversion seen last week in the yield curve and the slippage in equity prices may have been more a precautionary move in investment flows than a harbinger of a decisive move to pronounced risk off stance.

For now we’ll opt to wait and see and stay open to opportunities that could surface should a series of days of selling lead to some “babies that get thrown out with the bathwater.”

Experienced investors will likely recall the old adage of “buy low and sell high” should the market begin to mimic its behavior from last quarter.

A challenge to fundamentals does not necessarily determine that a recession lies ahead, but rather often reminds us that a detour does not a journey end.

As we went to press on Sunday night equity markets in Asia appeared to be following stateside stocks’ lead lower from Friday with European futures in the red.

From our perspective we opt not to jump to conclusions but rather keep things in context of a market that has shown a predilection for seeking near-term catalysts that enable sellers to take some profits without FOMO (fear of missing out) without breaking the longer trend of a bull market that is driven by secular globalization and technological trends. Both of those trends in our view are genies proven in recent and historical context to be mighty resistant to being forced back into their respective bottles.

We think the low levels of inflation registered in economic data have less to do with monetary policy tools that helped the US and other countries’ economies exit the financial crisis as they have to do with the effects of secular globalization and technology along with demographic trends worldwide that resulted in a change in the traditional balance (or imbalance) that can occur and affect supply and demand.

In the current environment we’d suggest that the risk ahead is not the reemergence of the shortages like those that drove the inflationary spiral of the 1970s and 80s, but rather it’s the abundance of commodities, goods and services (and the means of production) that have created overcapacity in many segments of commerce.

As a result the real challenge for central banks in most of the developed world and much of the more advanced economies of the emerging world is managing abundance. The very essence of abundance would seem to us to be counterinflationary.

Clues of these challenges on the economic landscape are found in wage and commodity price gains that are more modest than economists might have expected this late into an expansionary cycle (see our discussion on page 4 ahead). Consolidation evident in M&A (mergers and acquisitions activity) across a myriad of sectors appears in no small part to show businesses are addressing overcapacity that’s been created by systemic counter-inflationary trends generated by globalization and technology.