Hello Market Volatility My Old Friend

Hello Market Volatility My Old Friend

August 15, 2019

The most recent period of market volatility was accentuated by yesterday’s 3% loss in the S&P 500 due to fears that signs of a recession are beginning to appear.

Let’s talk about what it was that unnerved the market: the interest rate of the 10 year Treasury bond dropped below the interest rate of the 2 year Treasury bond. In a healthy bond market, lenders demand more return (yield) for longer-term bonds than for shorter-term bonds, all things being equal. However, every so often investors are willing to lock in a long-term return that is less than what they can get in a short-term bond investment. This is what is referred to as an Inverted Yield Curve.

Historically, an inversion of the yield curve has been a fairly reliable leading indicator of future recessions.  However, as with anything, it too has its drawbacks. For one, it tells us little about how severe the future slowdown might actually be. Secondly, once the yield curve inverts, it tends to precede recessions by an average of anywhere from 12 to 24 months. Most importantly, stocks have tended to go up during these periods where the yield curve is inverted.    

While we don’t know if the next recession will occur in the next 12-24 months, or if one comes how severe it will be, we do know that this is yet another example of the market “taking the escalator up and the elevator down”. The panicked, emotional reaction when stocks turn red quickly creates a framework for poor decision-making, even among Wall Street professionals.   

The good news is that you do not have to play the same short-term game of Wall Street traders or market timers to be successful.  By instead focusing over multi-year time frames (5-10+ years), your odds of earning above-average returns increase dramatically.  What drives stock prices over long periods of time are not yield curve inversions, trade tensions or which party controls Washington.  What drives stocks are the growth of revenues and cash flows.  To be sure, there will be challenging quarters and years where business fundamentals slow or contract. In our opinion, the trajectory is going to most certainly be higher in the long run.     

The fact is the inverted yield curve is telling us interest rates will probably remain at a lower level for longer than many expected just a year ago. Lower rates on safe assets like money market, CDs and bonds gives investors fewer options outside of stocks to grow their money meaningfully over long periods of time.  This is why we always tell you that the money you have in cash/money market/CDs should be there address your shorter-term spending needs.  Longer-term money is better suited in stocks.  Even with all of the volatility over the past 2 years, it is clear that the stock market has been better than holding cash, and by a large margin. 

Remember a long-term time horizon and perspective is your greatest asset in retirement. These day-to-day fluctuations in your portfolio have almost no bearing on your lifestyle and long-term plans.  This sounds simple in theory, but is hard for most people to fully accept.  Your investments/retirement savings are invested in a way to outlive you!  As such, judging the performance of your portfolio over a day or month, when you have 10, 20 or even 30 years to go is rationally unsound, but emotionally real.  Would it make sense to judge how a 26.2 mile marathon was going to go based on the first 100 yards?  The same logic applies to your investments. 

If you would like to discuss your situation specifically, we want to speak with you. 

For other previous blog posts, please click here.