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Strategic Insights

Volume 8, Edition 28 | August 12 - August 16, 2019

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Inversion Diversion

Doug_Walters Doug Walters | Articles

Read Time: 3:00 min

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A brief yield curve inversion had market-watchers talking of impending recession. Uncertainty is high, but we would caution against reading too much into this signal…

Contributed by Doug Walters , Max Berkovich

It was another volatile week for investors. Markets were rocked by a temporary yield curve inversion which some took as a signal of a pending recession (see our discussion below). Stocks fell 3% on Wednesday but ended the week down just 1%.

While the inversion was the headliner this week, the continued trade and tariff dispute between the U.S. and China played a close second, with investor sentiment fluctuating with every twist and turn. The protests in Hong Kong have added additional complexity to the negotiations. While the tariffs are hefty, in isolation, they are not large enough to meaningfully impact the economy. Instead, it is the knock-on effects that magnify their impact (the farmer who is waiting for better demand visibility to invest in new equipment, and the manufacturer who is cutting overhead to cover the added cost of imported inputs). Uncertainty stalls business investment which slows economic growth.

Long-term investors need not worry about these developments. Will the market decline? As some point certainly. But trying to outsmart the market is a losing battle. In the wise words of Peter Lynch, “Far more money was lost by investors preparing for correction, or trying to anticipate corrections than has been lost in corrections themselves.” We recommend focusing on what we can control, which is our portfolios. A well-diversified portfolio, matched to your risk tolerance, designed to stand the test of time, is always the best defense against uncertainty.

Spotlight: Yield Curve Inversion

What is this yield inversion I’m hearing about and does it mean a recession is coming?

There has been much talk about the inverted yield curve and its predictive powers, but what is it, and what is it predicting? The yield “curve” describes a chart of the rates an investor would earn on treasury bonds of varying maturities (e.g. 3 months, 2 year, 10 year, 30 year). Typically, the longer the maturity, the higher the rate of return on the investment. The intuition is simple: if you lend your money for a longer period of time, say 10 years, you are going to demand a greater rate of return than you would for a 2 year loan. An inversion occurs when rates of shorter maturities are higher than those of longer maturities.

This week, for the first times since before the great recession, the 10 year yield dipped below the 2 year. The move spooked equity markets, as the “2-10” inversion has preceded the past two recessions and seven of the last nine.

So, are we headed for a recession? Only time will tell, but we would highlight a few facts. First, even if this proves to be a recession signal, typically a recession occurs nearly two years after the inversion. What is more, stocks have tended to go up meaningfully before they go down following an inversion. Would-be market timers are forewarned not to interpret that this week’s inversion as a near-term sell signal. Also, there is the (always dangerous) case that “this time is different.” Previous inversions have occurred in much higher rate environments. In a low rate environment, the yield curve is much more subject to demand and policy distortions, which could result in an inversion.

In the words of former Fed Chair Janet Yellen, “Historically, it has been a pretty good signal of recession, and I think that’s when markets pay attention to it, but I would really urge that on this occasion it may be a less good signal.”

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The Week Ahead

The main focus next week will be on the annual Jackson Hole Symposium in Jackson Hole, Wyoming.

  • The major theme this year will be “Challenges for Monetary Policy.”
  • Fed Chairman Jerome Powell is scheduled to speak during the three-day event and experts will be watching for any hints in regards to future interest rate policy.
  • The Fed will also release their minutes from their July meeting, where they initiated a 0.25% cut to interest rates.

A couple of our portfolio companies release earnings next week, including The TJX Cos. (TJX-US).

  • Experts like that TJX benefits from the “retail apocalypse” due to their purchase of inventory from downsizing and liquidating retailers.

Wednesday will mark the start of the Great New York State Fair in Syracuse, NY.

  • Last Year’s record-breaking attendance was over one million, a 30% increase from 2017 and double the crowd of 2016. Fried Oreos anyone?

Saturday (8/24) Strategic Financial Services will be sponsoring its first annual cornhole tournament at the Art & Music Festival, in Clinton, NY.

Stock Highlights from Max

Eye on the world

Economic worries from China and Europe spilled over to crude prices, which pressured the Energy sector. The sub $55 barrel of oil prices caused the sector to underperform the Industrial and Financial sectors, which had a forgettable week. Despite interest rates moving even lower, the Utilities and REIT sectors were beaten by Consumer Staples for the lead position on the heels of a great earnings report from…

Walmart

Walmart, Inc. (WMT) beat expectations, including reporting sales over $1 Billion stronger than analysts expected. The beat was only the start for the retailing goliath. Comparable sales were 2.8% higher in the quarter, eCommerce was 37% higher, and the company served up upbeat guidance as well. Walmart has now reported its 20th straight quarter of sales growth. CFO Brett Briggs said Walmart raised prices on some items due to tariffs, but it is not passing all the costs to consumers. Rather, it is forcing suppliers to cut costs and find alternative sourcing.

Cisco

An earnings report that wasn’t as well-received this week came from Cisco Systems, Inc. (CSCO). While the switches and routers giant beat expectations by its customary penny, weaker guidance tripped up the stock. This report, according to several analysts, was a hint of the slowdown in the global environment.

Deere

The last earnings report of note came from Deere & Co. (DE). Earnings and revenue were weak, ravaged by tariffs. Deere’s most significant segment, Agriculture Machinery, witnessed a 24% year-over-year decline in operating profits. The stock responded well, as results were feared to be worse. The company left investors with a tease of further cost cuts to adjust to the challenging environment but punted the details to next quarter.

About Strategic

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