It's HOT, HOT, HOT

by Tom Wargin CFP®, CFA

The stock market has scorched upward in the first six months of this year making it the best start in over 22 years as record heat also grips the world in July. In addition, the bond market is up as the anticipation of falling interest rates by the Central Banks has flipped the script from late last year. While that is occurring, the IPO (initial public offerings) market is going crazy as everybody is trying to buy the next Amazon.  Time will tell if Snap, Uber, Lyft or who knows which company will soar. This is beginning to remind me of 1998 or 1999 as a precursor to the market collapse in 2000.

As interest rates inverted slightly when the rate on the 3 month treasury became higher than the rate on the 10 year treasury bond, the big question on a contrarian investor’s mind is: When is the next recession coming? There is usually a 12-18 month lead time from inversion to the actual start of a recession so a market collapse does not appear imminent. Vanguard recently did up their probability of recession from 30% to 40% in the next 12-18 months, but they caution that they do not see it as their base case yet because Fed policy hasn't become fully restrictive.

In addition to interest rates, the economy is slowing and GDP growth rates are coming down as Vanguard lowered its expectations from 2.0% to 1.7% by the end of the year and other firms and economists are lowering theirs also. Concern is coming from weakening job growth and housing market.

As for the international outlook, Chinese growth rates are slowing and few are betting that the US – China trade dispute will be settled shortly. Brexit is still an issue and we’ll see if Boris Johnson can work something out better than Theresa May was able to. Geopolitical uncertainties and fears of another 2008 have made many investors quite skittish. We have received calls from some expressing those same thoughts. Our strategy at this time: we are trying to be at 65-70% of our normal equity allocation. We are also staying overweight in short term income, but for our more aggressive clients we are adding some intermediate to long term income holdings.

Playing the economist and looking “on the other hand”, since there is a 12-18 month lead time before recession or a 6 – 12 month lead before a possible market decline, the market may continue to surprise on the upside in the near term as the Fed follows through and does lower interest rates. This raises the question in my mind of whether 2019 will look more like 1987, 1998, or 1999. So far 1998 or 1999 looks like a better comparison.

Both 1987 and 1998 had large stock declines during the year but recovered most or all by year-end. While 1999 didn’t have a large decline, it epitomized “irrational exuberance” and later got the moniker “dot com bubble”.  What will be the title that gets applied to the end of this cycle? Stay tuned!