The Biggest Risk as of August 2019

By: Matt Garrott

Midway through August nearly every media outlet posted a RECESSION headline.  Even the Cleveland Plain Dealer ran a front-page story.  The yield curve had inverted (the yield on shorter maturity bonds was higher than longer maturities), leading some to jump to the conclusion that a recession was imminent.  After all, the yield curve has “predicted” every recession since 1980.

Yield curve inversion is a leading indicator in a broad sense, though.  The “predicted” recessions followed an inversion by an average of 22 months and the yield curve stayed inverted during most of that time.  If the yield curve remains inverted for over a year, maybe it would be time to look for other signs of upcoming recession.  According to the St. Louis Federal Reserve, our current situation does not fit this pattern.

Most economic data are positive, however.  Unemployment is low.  Inflation is tame.  The United States economy is robust, especially relative to the rest of the world.  Despite a trade dispute with China, foreign investors see the US as a stable place where their money can earn a positive interest rate.  Bad economic data has so far been limited to one-off monthly hiccups and anecdotal quasi-data such as Recreational Vehicle sales.

It’s important not to let economics stories (positive or negative) drive investment actions.  The stock market can drop in a healthy economy just as it can rise during a recession.  Constructing a portfolio around a prediction is a sure way to bleed wealth.

With global bond yields pushing zero (and sometimes below that!) it seems that investors are being nudged to allocate more to risky assets in search of returns.  There is a cliché that the newest generation of money managers, financial advisors, and their investors has never seen a bear market.  Risk has fallen off the long term (ten year) statistics in many traditionally volatile asset classes such as high yield bonds.

The biggest risk to your wealth right now is not a trade war, Brexit, or recession.  It’s the temptation to embrace risky assets in pursuit of higher returns or higher yields.  These assets are being marketed aggressively with little to no acknowledgement of how they behave in a truly negative environment.

This is not a new risk.  It’s just another story of how investor behavior dictates portfolio returns more than any other factor.  Investors who have spent more time in the market are less likely to chase returns, yields, or other investment story du jour.  They understand that activity does not translate into favorable outcomes.

Fairway Scorecard 8-31-2019