Economic Update: Recent Market Volatility

There has certainly been a lot of economic news in the past year. “Inverted Yields”, China trade talks, up-coming Presidential elections, slower “Gross Domestic Product” numbers and will “The Fed” cut the interest rates? We understand that these are real portfolio risks and your HORAN Investment Committee continually discusses how to minimize the impact of any potential market declines.

One of the many headlines grabbing attention is the inverted yield curve that occurred this past week for one day, meaning the interest rate on 10-year Treasury note was less than the interest rate on the 2-year Treasury note. This went back to a positive yield curve by the end of that day.

Ordinarily, an inverted yield curve may reflect that markets expect an economic slowdown or recession thus lowering future interest rates. This signal may be followed by a credit creation decline as financial institutions become less incentivized to provide credit (loans) due to declining profitability from taking shorter-term deposits while lending out longer-term funds. A slowdown in credit creation ultimately inhibits economic growth, which may, in turn, contribute to a recession.

Given the significant extent to which the Federal Reserve has influenced the short-end of the yield curve, some economists contend that inverted yield curve implications may be less clear than in the past.

In April, Chief Executive Officer of JPMorgan, Jamie Dimon, noted in an annual letter to investors that he “would not look at the yield curve and its potential inversion as giving the same signals as in the past… There has simply been too much interference in the global markets by central banks and regulators to understand its full effect on the yield curve." 

It bears noting that 25% of global government bonds, valued at approximately $15 trillion, currently trade at negative yields. Some market observers concluded that these negative yields led to significant global demand for longer-term US Treasuries depressing long-term rates, thus impacting the shape of the yield curve.

The stock market is unpredictable -- all of the time. While stocks can be wildly unpredictable over short periods of time, they are surprisingly predictable over long periods.” - Warren Buffett 

A correction is no reason to exit the market as displayed by the chart below. The blue bars indicate annual US stock market returns and the green diamonds represent the corresponding yearly low. For example, in 2016 the market ended the year up 12.00% even though the market was down 10% at a point in time during that year.

Over the past 30 years, the S&P 500 has experienced 16 “during the year corrections,” of at least 10%. Of these 16 corrections, the calendar year ended with a positive return 11 times.

The HORAN Investment Committee has taken steps within client portfolios over the past year in advance of this expected and ongoing volatility. We shifted to increased US large cap exposure and took a less stake in international and emerging markets. The main reason for these changes was to lower our overall market risk and to hedge in the event of a recession or a down stock market environment. We also made changes to our Real Estate position and added MLP investments. With these changes, the portfolios typically have a slightly higher income “yield.”  In most markets, having a higher income “yield” will perform better in a declining stock market or declining fixed income yield cycle.

Thank you for placing your continued trust in HORAN. Please contact your advisor with any questions or concerns you may have.  



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