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THIS WEEK'S UPDATE

| August 19, 2019
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THE WEEK ON WALL STREET
Volatility continued to hold center court in a big way last week as stocks took a wallop mid-week after a temporary inversion in the yield curve.  The U.S. - China trade dispute played a large part in the major indices losing ground for a third straight week.
 
U.S. stock indices saw significant ups and downs last week, with traders looking for economic cues from Treasury yields and also developments in the tariff fight between the U.S. and China.  The S&P 500 lost 1.03% on the week; the Dow Jones Industrial Average and Nasdaq Composite respectively declined 1.53% and 0.79%. Overseas shares also retreated: the MSCI EAFE index lost 2.34%. 
 
ATTENTION ON THE BOND MARKET
Wednesday, the yield of the 2-year Treasury bond briefly exceeded that of the 10-year Treasury bond. When this circumstance occurs, it signals that institutional investors are less confident about the near-term economy. That view is not uniform. Asked whether the U.S. was on the verge of an economic slowdown, former Federal Reserve Chair Janet Yellen told Fox Business “the answer is most likely no,” noting that the economy “has enough strength” to avoid one.  The demand for bonds has definitely pushed prices for 10-year and 30-year Treasuries higher, and their yields are now lower (bond yields usually fall as bond prices rise). The 30-year Treasury yield hit a historic low last week.
 
They say a picture is worth a thousand words.  Here's the 2 - 10 Treasury yield curve inversion.  Enough said?  




 
Probably not, but it's a simple concept to understand - an inversion means short-term rates are higher than long-term rates.  This happens when investors rush to buy Treasuries at any cost, and/or the demand for credit is "soft."  Not all inversions have to precede a recession, that's the good news.  Now here's the bad news - the past seven recessions have been preceded by a yield curve inversion, with an average lag of seven to twenty-four months from peak to start of the recession.
 
Now wait a minute, just recently, we said that we were not calling for a recession and we stand by that belief.  How do we reconcile last week's comment with this week's volatile reaction?  Let's look at the economic data to support our conviction.
 
According to the Federal Reserve Bank of Atlanta, The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2019 is projected to be 1.9%. (Source: Federal Reserve Bank of Atlanta) These guys are pretty good at forecasting.  It is an undeniable fact that we have never had a recession with GDP growth and low unemployment.
 
Did we have an inversion? 
Yes.
 
Does that mean there's a recession right around the corner? 
No.
 
A lot will be riding on how the Fed reacts over the next few months.  There's no magic elixir that can be found in Jackson Hole this week.  The tone of their comments could serve as calming voice of reason.  Perhaps political naivete played into Chairman Powell's words when he mentioned the economic uncertainties of the trade war.  The Fed alone will not be able to solve the uncertainty.  The White House needs to get a deal done with China to help curb the volatility.  A political reversion to free trade alongside Fed easing should provide a stable path to prosperity.
 
Have we seen the worst? 
Maybe, maybe not.
 
The yield curve is flat but not quite inverted, and the Fed has the tools to help normalize it.  Our economy is doing well ... and markets should continue to do well as long as we remain focused.  High quality investments in our portfolio help us weather these volatile cycles.  We remain focused on companies with strong balance sheets and solid track records.  We believe this to be a prudent strategy yesterday, today and tomorrow. Volatility is a normal occurrence and we believe we are in a bull market until proven otherwise.
 
SOME CHINA TARIFFS POSTPONED
Last week, the Office of the U.S. Trade Representative announced that about half the Chinese imports slated to be taxed with 10% tariffs starting September 1 would be exempt from such taxes until December 15.  The White House said that the reprieve was made with the upcoming holiday shopping season in mind, so that tariffs might have less impact on both retailers and consumers.
 
THE WEEK AHEAD: KEY ECONOMIC DATA
Wednesday: The minutes of the July Federal Reserve meeting and the latest existing home sales data from the National Association of Realtors.
Friday: Federal Reserve Chairman Jerome Powell delivers a speech at the Fed’s annual Jackson Hole economic conference on monetary policy, and July new home sales numbers arrive from the Census Bureau.
 
THE WEEK AHEAD: NOTABLE COMPANIES REPORTING EARNINGS
Monday: Baidu (BIDU), Estee Lauder (EL)
Tuesday: Home Depot (HD), Medtronic (MDT), TJX Companies (TJX)
Wednesday: Analog Devices (ADI), Lowe’s (LOW), Target (TGT)
Thursday: Salesforce (CRM), Intuit (INTU)
 
FINAL THOUGHT
Lower interest rates on bonds are now influencing mortgages. According to mortgage reseller Freddie Mac, the average interest rate on a conventional 30-year home loan was just 3.6% last week. That compares to 3.81% roughly a month ago (July 18).

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