Stocks remained under pressure last week, as the S&P 500 fell by 1.03 percent to 2,888.68. That still left the benchmark index up 15.23 percent 2019-to-date, and just 4.53 percent below the all-time closing high. A potential de-escalation in the trade war between the United States and China buoyed equities earlier in the week, but the bears regained control after a certain measure of the yield curve inverted. Specifically, the yield on the 2-year Treasury note exceeded the yield on the 10-year Treasury note for the first time since 2007. This worries some market participants because the 2s and 10s curve has inverted ahead of each of the last seven recessions in the U.S., as well as nine out of the past twelve recessions. The precision of this indicator, though, is not very impressive because there have been false positives when parts of the yield curve inverted but no official downturn occurred. Further, the average lead time between an initial inversion and the beginning of a recession has historically been around a full year, and in the particular case of the 2s and 10s curve, inversion has typically occurred around 19 months ahead of the next recession and 12 months before the cycle peak in the S&P 500 index.
The 2s and 10s spread would likely also need become more negative and remain so for a prolonged period before the curve should really be paid close attention to, especially since the Fed’s QE purchases of long-dated Treasury securities might have exacerbated this latest inversion. However, just because an outright recession may not be an imminent threat that does not necessarily mean economic growth will remain elevated. This is probably one of the reasons why the curve is shifting in the first place since concerns are rising that the much weaker economic conditions overseas will eventually spillover to the United States. Moreover, economists prefer to look at the real (inflation-adjusted) yield curve and view inversions not as a recessionary guarantee but instead a sign that growth could decelerate and in turn leave the economy more exposed to a negative shock. This should provide more motivation for lawmakers in Washington to avoid unneeded headwinds such as government shutdowns and extended trade wars. Add to all of this the various other unknowns for market participants still to digest in the near-term and it would not be too surprising if volatility continues to pick up. Any regular investors unsure how to navigate this environment should consider consulting with a professional financial advisor and as always, we are here to help with any questions you may have.
To recap a few of the things we learned about the economy last week, the positives included that homebuilder sentiment firmed, mortgage applications surged, single-family housing starts and building authorizations increased, regional manufacturing activity rebounded, small business owner confidence improved, productivity growth exceeded forecasts, and retail sales jumped. As for the negatives, household inflation pressures firmed, initial jobless claims rose, industrial production unexpectedly declined, capacity utilization fell, and consumer optimism deteriorated. This week the pace of economic data slows down considerably but there are still a few important reports on housing, factory output, and employment scheduled to be released. Other potentially market-moving events to watch this week include a speech from Fed chair Jerome Powell, the annual Economic Symposium in Jackson Hole, and the release of the minutes from the July FOMC meeting.
What To Watch:
- E-Commerce Retail Sales 10:00 AM ET
- Randal Quarles Speaks 6:00 PM ET
- MBA Mortgage Applications 7:00 AM ET
- Existing Home Sales 10:00 AM ET
- EIA Petroleum Status Report 10:30 AM ET
- FOMC Minutes 2:00 PM ET
- Jackson Hole Economic Symposium
- Jobless Claims 8:30 AM ET
- Leading Indicators 10:00 AM ET
- EIA Natural Gas Report 10:30 AM ET
- Kansas City Fed Manufacturing Index 11:00 AM ET
- 30-Yr TIPS Auction 1:00 PM ET
- Jackson Hole Economic Symposium
- New Home Sales 10:00 AM ET
- Jerome Powell Speaks 10:00 AM ET
- Baker-Hughes Rig Count 1:00 PM ET
Sources: Econoday, Bloomberg, ZH, BofAML, Twitter, FRBSL
Post author: Charles Couch