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The environment has become decidedly more fearful over the past several months, which have featured a market correction, lots of volatility, and forecasts for lower economic growth over the next several years. The economy is cyclical, and there is some justification for prudent appraisal of risk in light of the expected slowdown, but that is a different animal than a recession, which is what the pundits are talking about lately. Consensus expectations show the economy growing at 2.9% for 2018, 2.6% for 2019, and 1.9% for 2020. The underlying indicators all seem to be holding up for now, so we do not see a sustained downturn in the economy as probable just yet. With that said, the markets are a discounting mechanism and have historically started falling before the economy peaks. For now, we expect the economy to continue growing, albeit at reduced rates compared to this year.
The S&P 500 remains down, being approximately 6.7% below its highs reached in September. Several things are important to note about the US Equities market in general. For one, the VIX index remains elevated. This index measures investor expectations of future volatility as a function of the prices of options contracts, and as such, represents actual bets or prices of risk from the point of view of large investors or groups of investors. Big players in the markets appear to be concerned with risk based on options pricing, and that is something to watch. Furthermore, during the recent downturn large-scale movement has been seen from cyclical sectors such as industrials, consumer discretionary, and technology into defensive ones such as consumer staples, utilities, and health care. This follows the same theme and shows significant sums of money moving from positions that benefit from the upswing in the economic cycle into those which defend capital the most during cyclical economic downshifts. In short, it appears that large investors and groups of investors are getting into positions that will protect them somewhat if/when economic growth slows down. Coming into the end of November, we are seeing a rally in stocks and reduced reading of volatility relative to its recent peak. If this continues, we expect the market to continue back up to retest its recent highs. We have not altered our market forecasts, and see the year ending with the S&P 500 higher.
The 10-year Treasury is yielding 3.06%, roughly in-line with last month’s reading. A year ago, it was at 2.46%. What is more telling is the short end of the curve, where 6 month T-bills were yielding 1.27% last year and today yield 2.53%. The yield curve has flattened, but we are starting to see signs of rising yields on the long end of the curve. In other words, we are not expecting the curve to invert, which has been a reliable precursor to recession, anytime soon.
We see this term, beta, frequently in terms of investments, but what does this mean? Simply put, this is a statistical term that boils down to a measure of how one specific thing moves in relation to another. In the field of investing, it is used to describe how an individual security is expected to move in relation to a benchmark, usually the S&P 500 for US Stocks. The beta represents some multiplier of the (percentage) performance of the benchmark. To clarify, the stock of Apple Inc. has a beta of 0.997, which being very close to 1 means that if the S&P 500 goes up or down 1% the stock is expected to do the same, or go up by 1 times the performance of the S&P 500. The stock of Public Services Enterprise Group, a utility company, has a beta of only 0.526. This means that if the S&P 500 goes up or down 1%, this stock is only expected to move by about 0.526%. This illustrates how beta can be used as a proxy for market risk, which is the part of investment risk related to general market conditions. This is also why utilities and consumer staples companies tend to be viewed as “defensive,” because typically having low betas, they are expected to decline a lot less than the market during downturns.
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