The word Recession hit the airwaves on August 14th and a stock market sell-off ensued. The Dow dropped 800 points (-3.05%) on that day. The catalyst was the inversion of the yield curve. The yield on the 10 Year US Treasury fell below the yield on the shorter 2 Year Treasury. A typical relationship is for the longer term Treasuries to pay a higher yield than shorter term. Many times in the past an inverted yield curve precedes a recession. The fact is it has been as long as 18 months to 2 years following the inversion before the economy moves into recession. Typically the inversion should last at least 3 months to be a credible signal and that has not happened this year.
A recession is defined as two consecutive quarters of negative GDP growth. We have not had one quarter of negative growth and the economy is strong. Leading up to a recession we expect to see high unemployment and today we have historically low unemployment. We expect to see stagnant wages and currently wage growth exceeds inflation including among low paid workers. We also expect to see a lack of consumer confidence and slowing retail sales. Consumer confidence remains high and strong retail sales were reported in August.
While our economy is strong, there are negative international pressures on our markets. Concern over trade is valid and the stand-off with China is moving markets on almost a daily basis. It is becoming increasingly apparent that a resolution is likely to take a long time. There is not much that the two sides of the political spectrum agree on these days, but resolving trade with China is one point of agreement. We can no longer kick this can down the road. The issues which go to our national security must be fixed and sooner is better than later. Only time will tell how this matter is ultimately resolved, but there is a consensus that China needs a resolution more than the US. In the short term, expect tariffs and trade to continue to cause volatility in our markets. Often as time goes by, investors become less moved by the day to day news and that may become the case with China trade.
Another global issue continues to be the UK’s exit from the European Union. The deadline now is October 31st which is coming fast. The way the UK handles this may open the door for other nations to exit, and the future of the EU is at stake.
Finally, it is expected that the Federal Reserve will lower short term rates another 1/4th of a percent in September. It is not usual for the central bank to lower rates in a strong economy but the rest of the world has lower to negative rates, so there is a lot of pressure on the US not to raise rates too fast. Our higher rates have caused foreign money to flood our bond market this month, driving prices higher and yields lower.
Looking back to the end of August 2018, our stock market is essentially flat over the last 12 months. Month to month there has been high volatility with little progress as investors react to trade talks, interest rate uncertainties, and recession forecasts. As August ended the outlook for the domestic market is still in positive territory.