In last month’s newsletter I discussed some of the conditions that precede recessions. One of them was an inverted yield curve. This is a condition where short term interest rates become higher than long term rates. While the yield curve has flattened of late, it is far from inverted. Looking back at the last 5 recessions, once the yield curve hit 0.50%, it took a median of nearly a year before the curve inverted. Once it inverted, it took about 20 months until a recession started. All along the way, the S&P 500 Index posted a median return of 21.5% over these 32 months. In other words, there could be years left to this expansion before the yield curve truly becomes a worry.
Another current concern is interest rates. The Ten Year U.S. Treasury Bond recently rose above 3.0% and this is considered the reason for recent stock market weakness. The reason some investors fear rising interest rates is that at some point, if rates keep rising, bonds may become a more attractive and less risky play than stocks, thereby pulling investment from stocks to bonds and causing further equity market declines. LPL research has looked into the data and their conclusions suggest otherwise. LPL has found that stocks and bond yields historically have been positively correlated until the 10 – year gets up around 5%, at which point the correlations break down. In other words, it is perfectly normal for yields to rise along with stocks. Taking this a step further, of the most recent 23 periods of higher rates, stocks have gained ground 19 of those times. Recent periods have produced even better performance, as stocks have risen during each of the last 11 periods of rising rates since 1996. Stocks have done well since interest rates began to move higher in September 2017. History suggests that higher rates may actually be a good thing and should the 10 – year Treasury yield significantly break above the psychological important 3% level, the equity bull market may garner further support.
Ultimately, earnings growth is the driver of equity prices. LPL is looking for S&P earnings growth to approach the mid-teens in 2018, with many expecting even stronger growth. What is interesting about this is even though corporate profits are expanding and making new highs, some are predicting trouble for stocks as earnings growth potentially slows later this year or in 2019. LPL research doesn’t see it this way. They expect the bull market to continue in 2018.
Understand, there will always be concerns and fears. We never get to invest money in perfect times. Trade and Tariffs are now a worry and of course, who knows how this summit with North Korea will turn out. I hope you and yours are healthy and doing well. We are here to answer your investment questions should you have any. Enjoy the warmer weather. – Mark
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Economic forecasts may not develop as predicted. Some of this research material has been prepared by LPL Financial. All indices are unmanaged and may not be invested into directly. Referenced material: LPL Research Weekly Market Commentary & LPL Research Weekly Economic Commentary, both dated April 23, 2018. Approved Tracking #: 1-723956.