Canadian and U.S. stocks declined on persisting signs of a global economic slowdown and renewed yield-curve worries.The White House announcement that some tariffs scheduled to take place in September would be delayed until December instigated a short-lived market rally. This rally was later reversed by disappointing German and Chinese economic data, and by a brief inversion of a closely watched portion of the U.S. yield curve. The 10-year U.S. rates dipped below two-year rates for the first time since 2007, and 30-year yields fell to a record low near 2%. Similarly, in Canada 30-year yields touched a record low of 1.34%. Economic news was not completely lopsided to the negative, however. U.S. productivity grew at a healthy pace, and U.S. retail sales for the month of July were up the most in four months. In our view, recession fears are overblown, but lingering global uncertainties are likely to keep volatility elevated. We believe reasonable valuations, low interest rates, and still-solid economic fundamentals are all supportive of stocks to continue to move higher, but with periodic hiccups along the way.
In addition to flight delays and middle seats, one of the more uncomfortable aspects of flight travel is turbulence. Turbulence, or sudden changes in air flow, can be a major source of anxiety for travelers and sometimes the scariest part of a flight. However, modern planes are designed to withstand much more turbulence than even a frequent traveler will experience in his or her lifetime, and the risk of plane damage or passenger injury due to turbulence is extremely small. Understanding the causes of turbulence and the tools pilots use to combat it can help calm passenger jitters.
Turbulence is described as episodic bouts of chaotic air flow that disrupt calmer underlying flight conditions. Investors experienced their own version of turbulence in the markets last week, centered in U.S. markets and echoing more softly through Canadian markets as well. The S&P 500 swung from being down by as much as 2.9% due to trade uncertainties to up 1.5% as new tariffs were delayed until the end of the year, only to fall again due to pessimism stirred by negative signals from Germany and China of slowing global growth. Bond yields also dropped unexpectedly, as both U.S. and Canadian 30-year government bond rates fell to the lowest level in history. By the end of the week stocks had climbed from their lows and the 30-year yields in both countries had edged up only slightly from record lows.
Just as air turbulence is a normal part of flying, market volatility is a normal part of investing, though that does not make it any less anxiety-producing for investors. Our outlook is that equities will continue to climb, but bouts of volatility will be more frequent, as uncertainties tied to trade tensions and slowing global growth have grown. Understanding the sources of volatility and the tools used to combat its negative effects on investor portfolios can help make the flight more comfortable.
Flight Conditions: The economy is a slowing but still-solid support for the bull market to continue. New data on U.S. retail sales signaled that consumers continue to spend at a healthy clip. July retail sales improved 0.7% from the previous month, increasing for the fifth straight month in a row. Data out last week also showed that consumer prices rose in the U.S. This is a positive economic signal for the Federal Reserve, which had cut benchmark interest rates on concerns of too-low inflation earlier this month. Consumer spending has been the engine of growth for both the Canadian and U.S. economies, with consumption supported by a healthy labour market and low interest rates.
The Jet Stream: Bonds are flashing yellow, not red. Recession fears resurfaced over the week as a section of the U.S. yield curve, the 10-year and two-year, inverted briefly for the first time in three years. Currently, bond markets are reflecting investor concerns that slowing global growth and escalating trade tensions will derail the current economic expansion. Historically, U.S. yield-curve inversions have been associated with recessions, but that hasn't been true in other countries. Recessions, like turbulence, are very hard to predict, and the time between an inversion and the start of a U.S. recession has ranged from six months to three years.
Moreover, we think a yield curve as a recessionary signal is only part of the story this time. During other inversions, the Federal Reserve has played a role by increasing short-term rates to the point where they rose above longer-term rates. With the Fed cutting short-term rates this month for the first time in a decade, this most recent inversion is also reflecting very low to negative interest rates around the world due to central bank stimulus in the eurozone, China, Japan and other leading economies. Meanwhile the Bank of Canada has held short term rates steady to support the country's rebounding economy. Continuing monetary stimulus and expectations of future rate cuts from the Fed and other central banks are keeping long-term interest rates low, providing cheap access to credit for companies and consumers, which is also likely to help global growth stabilize in time and extend the bull market.
Turbulence: Market volatility is still within normal ranges. Though the impact of this week's U.S. market volatility feels jarring, it is not unusual by historical standards. A common way to measure the stock market's expectation for turbulence in the future is the Volatility (or VIX) index. As shown in the chart below, from 2013-2018 market volatility has been in line or lower than the near 30-year average of the index's history. So far this year, below-average market volatility has continued. In fact, over the 100-year lifespan of financial markets, bouts of volatility of 5% or more have occurred three times a year on average. There have been two 5% pullbacks in the U.S. so far this year, but none in the TSX.
Source: CBOE Volatility Index, Federal Reserve Bank of St. Louis
Flight Path: A higher climb, though bumpier along the way
Despite the turbulence of the past week, U.S. stocks are up 16.5% this year and Canadian stocks are up 15% including dividends.1 Like turbulence, occasional bouts of volatility are hard to predict and can feel uncomfortable. However, the greater risk to long-term investors is deviating from their wealth-building strategies in response to short-lived market swings. The way to ride out occasional bumps of turbulence as an investor is to keep a long-term perspective and focus on the tools that help keep portfolios on track – diversified investments and an appropriate mix of stocks and bonds that align with the investor's comfort with risk. While the flight may not always be smooth, what matters most is arrival to the investor's desired destination – the attainment of long-term financial goals.
Source: 1. Bloomberg
Nela Richardson, Phd
|S&P 500 Index||2,889||-1.0%||15.2%|
|10-yr GoC Yield||
Bloomberg, 08/16/19. *5-day performance ending Thursday. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.
Economic data being released in Canada include inflation on Wednesday and retail sales on Friday.
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Diversification does not guarantee a profit or protect against loss.
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