Week 34 Sitrep

Don’t let the final results fool you – the S&P 500 Index was down 0.94% last week – that was a crazy week for stocks! On Wednesday we saw all the major indexes suffer a large down day only to recover on Thursday and Friday. In short, the volatility in the month of August has been very high. Smaller companies in the U.S. and international stocks performed the worst of all the indexes for the week ended August 16th.

Source: J.P. Morgan Asset Management, Weekly Market Recap, August 19, 2019

The trend for 2019 continued as larger companies with growth characteristics held up better than other asset classes. The traditionally defensive sectors of consumer staples, health care and real estate also outperformed the rest of the market while energy and financials took the largest hit for the week. Despite the challenging month of August, the S&P 500 Index of large companies is up more than 16% for the calendar year. The large growth companies mentioned above are contributing the most return for the year with the Russell 1000 Growth Index up better than 21%.1

Source: J.P. Morgan Asset Management, Weekly Market Recap, August 19, 2019

We have witnessed a substantial decline in yields for U.S. Treasury bonds over the last several months. The most-quoted bond, the 10-yr U.S. Treasury bond recently dropped to a 1.55% yield on Friday; the yield on the last day of 2018 was 2.69%. A similar response has occurred to the 30-yr U.S. Treasury bond with yields dropping from 3.02% to 2.01% in 2019.2

Source: J.P. Morgan Asset Management, Weekly Market Recap, August 19, 2019

Historically, longer-term bond yields will change based on the supply and demand of bonds in the market. In other words, when there is a demand for bonds, the yields on those bonds will typically fall as the price of the bonds will rise, all else being equal. If rates have fallen by 1% on long-term Treasury bonds this year, the demand for these bonds must be very strong.

What would be causing strong demand for long-term Treasury bonds? Treasury bonds are typically seen as a “safe” place to put money when uncertainty rises for investors. A few examples among many that drive investors to buy U.S. Treasury bonds include:

  • Rising geopolitical risks (higher tensions in foreign countries)
  • Anticipation of slowing economic data both in the U.S. and globally
  • Increased concerns over currency stability
  • Doubts over near-term valuations for stocks

However, we also recognize a recent phenomenon that has caused investors to own U.S. Treasury bonds that could be the reason for recent demand. According to Jeff Saut of Saut Strategy, the global market now has more than $16 trillion in bonds with negative interest rates.3 You read that correctly; when you buy a 10-yr German Bund (German government bond) you will receive a negative 0.72% yield. Why would anyone buy an investment with a guaranteed future loss?

Negative interest rates are part of an economic policy currently being pursued by the European Central Bank and the Japanese Central Bank. Both banks believe the purpose of the policy will stimulate growth by forcing investors to place money in riskier assets. Unfortunately, the net result so far has been to force investors to look elsewhere for safe investments with better yields. How about a pop quiz?

Which of the following investments would you rather own? You can only choose from this list:
10-yr German Bund yielding -0.72%
10-yr Japanese Government Bond yielding -0.24%
10-yr United Kingdom Government Bond yielding +0.48%
10-yr U.S. Treasury Bond yielding +1.55%

This is not a trick question and we are not trying to deceive you. Global investors agree that U.S. Treasury bonds are very attractive based on the perceived risk (low) and attractive yield (that would be a relative term). Thus, demand for U.S. Treasury bonds continues to rise and the yields continue to fall until there is an appealing alternative.

One final thought – when we compared the various reasons above for the strong demand for U.S. Treasury bonds, it’s true that the first two reason are present today. We have witnessed rising geopolitical risks (Iran, Argentina, etc) create uncertainty in the investment world. We also received a number of economic reports in late 2018 and early 2019 that caused questions over future economic growth. As we’ve stated in recent weeks, our investment committee does not see evidence for an economic recession in the U.S. economy in the next 3-6 months. Rather, the current economic reports are actually pointing to better economic growth than anticipated over the next few months.4 Bespoke shared a graphical version of the Global Citi Economic Surprise Indices which measures how economic data is received versus the original forecast. The recent upturn is very encouraging:

Source: Bespoke Investment Group, The Bespoke Report, August 16, 2019

Our investment committee continues to recognize the risk that is present in stocks due to changing investor expectations for economic growth. Our portfolio remains cautiously invested in large, high quality U.S. companies that benefit from strong consumer demand and growth in corporate earnings. We have been very pleased with the returns on conservative fixed income (bonds) in the portfolio, especially municipal (tax-free) bonds.

If you’d like to schedule a time to discuss your portfolio or the markets in detail, please feel free to call our office at (281) 616-5935. We welcome the opportunity to sit down with you and learn more about your situation so we can help you optimize your portfolio to meet your financial goals for years to come.

Engrave Wealth Partners Investment Committee

Bill Day, CFP®, CIMA

Taylor Parker, CFP®

Greg Parker

1. J.P. Morgan Asset Management, Weekly Market Update, 8/19/19
2. J.P. Morgan Asset Management, Weekly Market Update, 8/19/19
3. Jeff Saut, Saut Strategy, August 19, 2019
4. Bespoke Investment Group, The Bespoke Report, 8/16/19