Financial Insights

Investing in a “Wait and See” Economy

The yin and yang of U.S. markets were on display yet again over the last couple of weeks as the S&P first fell 3.3%, but then rose 4.4% last week. Even as the market dropped on Trump’s threatened tariffs on Mexico and as new jobs came in much weaker than expected, those tariff plans were abruptly canceled and the Fed hinted that a rate cut may be in the cards. If you feel that this makes financial strategy difficult for investors, physical investing decisions for firms can be equally challenging. While firms may choose a “wait-and-see” approach to capital spending and hiring, investors cannot wait. Some may think this calls for an overhaul in investing strategy, but does it?

By now, as a regular reader of our columns, you know that the recent volatility is by no means unprecedented. Indeed, it is common for the S&P 500 to see a decline of 5% or more several times in any given year. Most typically, the market will recover from those disruptions and end the year with a gain. But now, you might worry, the U.S. economic recovery has just passed the 10-year mark and a presidential election is only 18 months away. And recent economic data are showing signs of weakness even as tensions in the Middle East flare up.

Bond investors seem to be especially worried, given the 20bp decline in the 10-year Treasury yield over the last week, yet equity investors appear enthusiastic (or at least sanguine), pushing the S&P over 4% higher last week. The former seems to have become more worried about a recession, while the latter show signs of becoming less worried – and this just in the course of a couple of weeks. So is one group right, and the other wrong? Is there something inherently different about the two groups’ mental makeups?  Or are both equity and bond markets actually singing the same tune?

Let’s take a look at a few highlights (and contradictions) of recent developments:

So the data is mixed, but overall, the U.S. economy appears to be in reasonably good health.  Yet the bond market indicates that investors expect two-to-three rate cuts this year and assigns a probability of 86% to the first occurring with the Fed’s end-of-July meeting. Bond investors are placing the bet that bond prices rise further and yields fall; they are focusing on the weaker economic data and counting on the Fed to intervene. Equity investors are taking a longer view – the economy may very well be showing some signs of weakening, but will ultimately be just fine because they, too, are counting on the Fed to ease monetary policy.

Both groups are concerned about recession, but equity investors see the risk as manageable by the Fed except in the case of a larger trade war or heavier regulations – whether those be on the FANG group or on pharmaceuticals. Last Friday’s jobs report was a case in point. New net jobs came in much lower than expected for May at just 75,000 and revisions to prior months offset those additions entirely. But this only served to increase equity investors’ expectations that the Fed would step in to save the day by cutting interest rates. This has become the “Fed Put.” So equity prices rallied on Friday. And hints that Trump would back away from the Mexico tariffs (which he ultimately did Friday night), had buoyed stocks earlier in the week. That’s the “Trump Put” at work.

Note that these two “Puts” are driving equity and bond investors to appear to have two different views. But they don’t. A slide toward recession would cause the Fed to cut its benchmark interest rate, and if that averts a severe recession, we would see strength quickly return to the investing environment for equities. Equity investing is a long-term strategy, and a recession’s onset is unpredictable (and once it arrives, is short-lived). For those reasons, it remains as important today as always to adopt an equity-to-fixed allocation you can live with over multiple cycles.  The U.S. economy looks pretty good right now, but as Shoeless Joe advises Moonlight Graham, “Watch out for in your ear.”

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

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