Divergent Messages?

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by Ralph Cole, CFA
Director, Executive Vice President of Research  

As the second quarter came roaring to a close, stocks marched consistently higher while bond yields moved drastically lower. Those trends continued the first week of July, but it is doubtful that they can continue in unison much longer. Either the economy stabilizes and rates stop falling, or the stock market will inevitably take a break from this rise higher.

The first half of 2019 was a positive period for risk assets, with nearly every asset class posting positive returns. We felt that much of the returns in the first half of the year were simply payback for the steep selloff in risk assets in 2018.

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The rebound this year has been led by the feeling that central banks around the world will be riding to the rescue with lower short-term interest rates and renewed quantitative easing programs. We hope this to be true, but hope is not an investment strategy. We are 10 years into an economic recovery with stretched valuations, so we are somewhat nervous about putting all our eggs into the central bank basket.

Yields around the world are telling us that growth is slowing dramatically. If central banks are successful in stimulating growth again, we would expect longer-term interest rates around the world to rise. Currently, the U.S. 10-year Treasury yields 2.036 percent and over $12 trillion in sovereign debt globally yields less than zero percent - a record amount. These are levels that we would associate with a recession, not healthy growth.

We expect these divergent messages to be resolved in the coming months. The Fed most likely will give the market what it wants with a 50-basis point cut in the Fed Funds rate at the end of July. Anything less would be viewed as a disappointment. We also believe that the appointment of Christine Lagarde, current Chairwoman of the IMF, to head the ECB is a dovish message from the Central Bank of Europe. Ms. Lagarde has consistently championed lower interest rates and increased fiscal stimulus during her time at the IMF. Easy money needs to stimulate economic growth, not just provide fuel for risk assets.

Week in Review and Takeaways for the Week

  • Higher stock prices and lower bond yields are sending divergent messages about the health of the global economy

  • Many central banks around the world are easing in an effort to in stimulate the real economy, … which in turn will help support higher stock market valuations

  • We would expect interest rates to move higher if central banks around the world are successful in reversing the current economy slowdown