August 22, 2019
The year is 2012.
On September 13, 2012 the Federal Reserve delivered in a big way, unleashing Quantitative Easing 3 onto the nonbelievers of the economic recovery. This serving of monetary stimulus propelled the S&P 500 upwards by 14% per year (from July 1, 2012 through June 30, 2019), and as the chart below indicates, the broader economy found its footing soon thereafter.
Fast forward to today and many similarities exist, but so do some differences. We too wait for the Fed’s next move; however, we are embroiled in a trade war with China, an economic drag that did not exist 7 years ago. Another, and perhaps more important, difference between then and now is that the yield curve has inverted, and trillions of dollars of debt globally have negative yields. Neither statistic can be construed as a positive outlook on future growth.
What is interesting is that commentators speak as though the yield curve is a sentient force acting on its own, rather than a collection of market participants expressing their views of future economic growth. Absent significant global supply gluts or serious financial stress – we would argue that neither situation currently exists – an inverted yield curve can signal a loss of confidence. Uncertain monetary and fiscal policy cause companies to lose faith in their ability to forecast sales into the future. When this happens, these firms tighten their spending with spillover effects occurring up and down the supply chain. If the negative sentiment is not contained quickly, self-fulfilling prophesy can take hold, causing a real-world recession.
We do not know for certain if history is or is not repeating itself right now. It certainly is humming a familiar tune. What we do believe is that there is no underlying reason for a recession in the near term other than unnerved markets. If the Fed can manage the market’s expectations without triggering inflation, and the trade wars are contained, we may be seeing 2012 all over again. If any portion of this solution fails to instill confidence back into the real economy, then a recession in the not too distant future is not off the table. There can always be something: a stellar earnings season, great jobs numbers, an unexpected intervention by an overseas central bank, or any other glimmer of hope that provides a jolt of confidence the market needs. These would be welcome relief for a while, but until the tariff situation and uncertainty around Fed policy become more benign, it is hard to believe that we have seen the last of the volatility that has been upon us since July turned to into August.
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