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AAM Viewpoints – The Final Innings of Economic Expansion? This Game May Have Extra Innings

Inflection Point for Equities and Bonds

There is plenty of data out there that might lead investors to think that the ending days of the equity bull market are close. After all, this month will render the current bull market in U.S. equities the longest on record. The bond market has been signaling trouble for months as yield curves flatten and economic data suggest that the U.S. economy might be slowing. Trade worries have markets pricing in lower earnings growth and Fed rate cuts. We are now seeing several large investment banks declaring that the bear market for stocks has begun and that yields could sink lower. Is the glass half empty or half full? We think it might be time to take a closer look at the data. We think this could be an inflection point for stocks and bonds.

As of this writing, the S&P 500 is trading a few percentage points from its all-time high and the 10-year Treasury is trading near its 2017 low. President Trump is fighting trade battles on numerous fronts with seemingly all of our largest trading partners. What makes us believe that this doesn’t look like the beginning of something ugly? Well, because the earnings outlook, Fed policy commitment, employment reports and investor sentiment point to a longer cycle and higher equity prices.

What does the end of a bull market look like? Although market history doesn’t necessarily repeat itself, it tends to rhyme. Quoting Sir John Templeton, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” We would point out that we have anything but optimism or euphoria. Investor sentiment is very skeptical and fearful. One measure of investor sentiment that we follow is the CNN Fear and Greed Indicator. The reading for that index going into the end of May was 24 which indicates extreme fear. The indicator tends to be fairly accurate at measuring peaks and valleys of extremes, whether fear or greed. Thus, when we look for a market top and the death of the bull we look for signs of investor euphoria. We don’t find any sign of euphoria; in fact, we find the opposite.

What are other factors we look for to mark the beginning of an economic downturn? We look for inverted yield curves. Yield curves invert when short-term yields in the Treasury market are higher than longer dated yields. Looking back to post World War II, every U.S. recession has been preceded by an inverted yield curve. At the time of this writing, only the curve for the 10-year Treasury minus the 3-month Fed Funds is inverted (by about 40 basis points), although this curve has not commonly been used to define a significant inversion. The more common curves used are the 10-year minus the 2-year or the 30-year minus the 5-year. Both of those curves are not inverted and are, in fact, steepening from being nearly flat in 2018. The rule of thumb is that steepening curves tend to be coincident with economic expansion, not contraction. Additionally, on average, these curves must meaningfully invert for an average of 14 months before a recession occurs. Note the chart below showing the current steepening of the 30-year minus the 5-year Treasury which tends to lead the shorter curves when diverging.

colyer1_061719Source: Bloomberg | Past performance is not indicative of future results.

Next, we note that the most prolific gains to be had in a bull market are those that occur after a curve has inverted. According to UBS, the average 12-month return of the S&P 500 before an inversion is 15%, while the average return after an inversion is a lofty 29%. These observations were measured going back to 1968.


Our conclusion is that even though yields are moving lower and the market now prices in a greater than 98% chance of a rate cut in 2019 (according to Bloomberg), the curve does not indicate an impending downturn. It is in fact indicating an acceleration, which is in line with a dovish Fed willing to move toward more stimulus.

We also note that sovereign interest rates in Europe are solidly negative and almost at zero in Asia. The world appears to be looking at the relatively higher U.S. interest rates to quench their thirst for yield. We believe that the 10-year Treasury is very stretched at this point and that an inflection point is likely near. Our overbought/oversold indicator – otherwise known as Relative Strength – appears to be showing a reversal as well. Note the chart below showing the 10-year yield and the RSI (Relative Strength Indicator).

colyer3_061719Source: Bloomberg | Past performance is not indicative of future results.

Finally, at the peak of an expansion that is beginning to fail, we would expect to see sharply rising jobless (unemployment) claims. This comes from businesses’ slowing profits and need to perform layoffs to tighten their belts. Unemployment claims are reported every Thursday by the Labor Department and recent trends show unemployment claims running at cycle lows with no spikes in the data. Many people want to look at the Employment Situation Report that is published monthly. The United States is at 3.6% unemployment as reported for the May 2019 report. This is indeed low but not unheard of. At some point employment gains must moderate as we are running out of potential workers to fill the positions. The more relevant number might be to look at the Job Openings report (JOLTS) which currently reports that we have almost 7.5 million job openings. This number is hovering close to all-time highs and shows we have more jobs open than we have people to fill them.

colyer4_061719Source: Bloomberg | Past performance is not indicative of future results.

We note that the Q1 (1st quarter) GDP (Gross Domestic Product) of 2019, which recent history shows to generally be a weak number, came in over 3%. Current expectations for Q2 are around 2% growth. These are not negative numbers. We understand that tough talk and actions surrounding trade and tariffs has the market a bit on its heels, but there are always worries in the market. We think this healthy dose of skepticism keeps us firmly on the side of continued expansion and continued equity market gains. Do we believe that we are in the final innings of the longest expansion for the U.S. economy on record? Yes, we do. Do we believe this game will likely go into extra innings? Yes, we do.

Our conclusion is that investors know that “time in the market” is more important than “timing the market.” We stress that flexible asset allocation with continued exposure to the equity and bond markets is key. Thus, we would encourage investors not to get too spooked and make emotional decisions that lack long-term sense. We believe the data is telling us that the secular bull market in equities continues. We believe that the trade issues will be resolved as parties on both sides of tariffs are best served to find a middle ground and reach a trade deal. We think that global central banks are unanimously supporting the slowing of actions designed to ease monetary conditions.

CRN: 2019-0603-7462R  

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit


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