James C. Knapp, AIF®
I hope you and your family have enjoyed the summer making cherished memories. This is the time of year we transition into Back to School Season. As we get our families ready to begin their learning journey, I thought it would be good to help you continue learning of your own.
The Merriam-Webster dictionary defines learning as “to gain knowledge or understanding of or skill in by study, instruction, or experience.”
It is always a good idea to continue advancing your knowledge by studying as much as you can. This can be accomplished in many ways; through reading textbooks, autobiographies, specific podcasts, etc. Gaining knowledge through instruction is another great way. This can be accomplished by taking a class or seeking the counsel of an industry professional. I will suggest that learning through experience, specifically applied to personal investing, can sometimes be a painful process. Painful as this education can come from those occasions when we make mistakes. Those mistakes can be quite costly and damaging as you work towards financial freedom.
Albert Einstein said: “Know where to find information and how to use it ---that is the secret to success.”
This month’s article centers on helping you understand where to find the information (though a Google search is also efficient) and then applying that to your own personal situation to derive your investment approach. The information cited and discussed is not an all inclusive list. Please consider them as a starting point.
As I write this article, we are just 14 days until the S&P 500 bull market becomes the longest of all time, at 3,543 days, on August 22, 2018. This means everything is fine and there are no worries, right?
The U.S. is experiencing an 18 year low in unemployment, a resilient housing market, high business and consumer confidence numbers and the S&P 500 nears or is at all time highs. That is all great though I’d suggest not waiting for a financial crisis to occur to begin strategies that work towards protecting your portfolio.
There are many ways investing parallels horror movies. In the great horror movies, you don’t see the monster until later in the movie. The horror starts with a hint, and it’s not until the plot thickens that we see the horror unfold. The markets are also hinting at some horrors of their own.
Increasing interest rates, post crisis tight bond spreads and the potential for peak corporate earnings hint to a late cycle economic environment. And who can forget the US trade protectionist policies and ever intensifying geopolitical tensions.
Interest rates have recently begun to rise; which has some focusing on the yield curve and its potential to invert. The yield curve is basically the difference between the interest rates on short term United States government bonds and longer term United States government bonds. As of August 8th, 2018, the difference of the 2 year Treasury versus the 10 year Treasury is 28 basis points according to the U.S. Department of the Treasury’s website (www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield).
Typically in a healthy economy, the rates on long term bonds will be higher than short term bonds. The extra yield (aka interest) is to compensate for the risk that economic growth will likely cause an increase in prices (aka inflation). Lately, long term bonds have been slow to rise while the Federal Reserve has been raising short term rates. This has caused the curve to flatten and come close to inverting (shorter rates being higher than longer rates). The spread was at these levels last in 2007; right before the Great Recession.
Flattening alone does not mean the US is destined for a recession. Though an inversion, as New York Federal Reserve President John Williams said, is “a powerful sign of recessions.” According to research from the Federal Reserve Bank of San Francisco, every recession of the past 60 years has been preceded by an inverted yield curve. Their research can be seen at https://www.frbsf.org/economic-research/files/el2018-07.pdf. If you like visual representations, the Federal Reserve Bank of St. Louis has a good resource: https://fred.stlouisfed.org/series/T10Y2Y. It depicts the 10 year Treasury vs. 2 year Treasury and also allows you to gain a historical context.
Credit spreads also should be monitored. Risk premiums on investment grade bonds over comparable Treasuries have been rising since February. According to Jim Paulsen, Chief Investment Strategist at Leuthold Group, risk premiums or spreads on Baa-rated corporate bonds over Treasuries increased 2% this month based on data from Moody’s Investor Services. This milestone was reached either during or just before six of the past seven US recessions since 1970. Dallas Federal Reserve President, Robert Kaplan, told Reuters that while credit conditions are benign, they can deteriorate quickly.
I have suggested many times that negative returns & high volatility are typically destructive to wealth building. There are many strategies to consider that aim to protect your portfolio against potential risks. I remind you of this as there is still time to position yourself more defensively. Trade wars can heat up, volatility and inflation can spike rapidly to new highs, and markets can begin to pay greater attention to risks than they had before. When these things occur, that is when the horror begins!
If you would like more information about strategies that seek lower volatility than traditional portfolios of equities and fixed income, the Knapp Advisory Group is here to be a resource for you.
913-544-1509 or 314-323-7094
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The NASDAQ Composite is a stock market index of the common stocks and similar securities (e.g., ADRs, tracking stocks, limited partnership interests) listed on the NASDAQ stock market. Along with the Dow Jones Average and S&P 500 it is one of the three most-followed indices in US stock markets. The composition of the NASDAQ Composite is heavily weighted towards information technology companies.
The Federal Reserve Federal Funds Rates (Fed Funds) is the weighted average interest rate at which banks lend each other funds held at the Federal Reserve.