Sailors released, Brexit in a ditch, Huawei purgatory, trade talks about talks to have talks. Are the clouds lifting, or has the damage been done?
Stena Impero– Iran has released seven of the British tanker’s 23 crew members. This action has reduced tensions in the Strait of Hormuz and is being viewed as a positive first step in the efforts to release the whole crew and ship. The Stena Impero was seized by Iran in July as a retaliatory move after the UK detained an Iranian ship near Gibraltar that was suspected of shipping oil to Syria. These events will likely end by diplomatic means, but they reflect a general escalation of tensions in the area.
Brexit – Boris Johnson does not seem to be having any easier a time with Brexit than Theresa May, but is more passionate about the process. He would “rather be dead in a ditch” than delay Brexit. The markets also appear to have an opinion at this point, preferring the “deal” Brexit to the “no deal” Brexit, as the British Pound and FTSE 100 have rallied as the risks of a “no deal” outcome seem to diminish. The final chapter of Brexit has yet to be written and it is still a compelling drama.
Hong Kong – Carrie Lam, Hong Kong’s leader, has withdrawn the extradition bill that set off months of protests. The bill would have allowed the extradition of criminal suspects to China’s mainland and trial under the mainland’s opaque legal system. The protests caused chaos at transit hubs such as the airport, rail stations, in tunnels and on roadways. The 80 days of protests will have had an impact on the Hong Kong economy that may ripple into the world economy.
Huawei – At the G20 meeting in Tokyo, President Trump surprised with a concession allowing US companies to sell to the Chinese tech giant. Concerns surround Huawei and its relationship to the Chinese military and the potential for spying with its equipment. Additionally, this is an existential conflict about technological superiority into the future and the future is now with the oncoming upgrade cycle of 5G for wireless communications. Huawei is complicating an already complicated trade deal, weighing on the economy and impacting next generation technology. The conflict around technological superiority will be something to monitor over the years as the two powers that trade very closely with each other, also jostle for global influence.
Trade tension – The deal has been close, the deal has been far, the talks have been off and now there are talks to hold talks. The market whipsaws with every whiff of resolution or standstill. The trade tensions seem to ebb and flow inversely to economic and market strength. When the markets or economic numbers show weakness, the administration appears to soften their stance on the negotiations and when things improve the positioning hardens again. At the moment, we believe the economy is resilient enough to support the stock market, and should provide a stabilizing force to the ambiguity of the trade negotiations.
As we have discussed before, and is still the case, the opposite sides of the risk spectrum within the bond market are telling differing economic stories. The safer government bonds, when viewed via the yield curve, are suggesting a slowing is coming, while riskier high yield “junk” bonds, when viewed via credit spreads, are still quite sanguine about economic conditions.
Disclosure: Data as of August 31, 2019. Data sourced from Bloomberg LP. Recession dates defined by the National Bureau of Economic Research (NBER). 1/3 is the spread between the 3-year and 1-Year Treasury; 3/5 is the spread between the 5-year and 3-Year Treasury; 2/5 is the spread between the 5-year and 2-Year Treasury; 3M/5 is the spread between the 5-year and 3-monthTreasury ; 2/10 is the spread between the 10-year and 2-Year Treasury; 1/10 is the spread between the 10-year and 1-Year Treasury; 3M/10 is the spread between the 10-year and 3-month Treasury; Fed Fund /10 is the spread between the 10-year and Fed Funds rate (i.e. central bank rate). Data is for illustrative purposes and not meant to be relied upon for consumer trading decisions.
Cardan analyzes the eight different yield spreads above to assess the possibility of a recession. The average of these spreads represented by the purple line (the Cardan Aggregate Yield Curve) has been inverted for a few months now and, at the end of August, 100% of them were inverted (orange line). While the depth, breadth and duration of the inversion is substantial and may be indicating recession, credit spreads are not.
The chart below highlights the credit spread between US Corporate High Yield debt and the US 10-Year Treasury Bond (blue line) through September 12, 2019, which has not widened/increased substantially to this point and would, for now, point to continued stability.
The below chart combines the Cardan Aggregate Yield Curve and the Cardan Recession Watch Line, through July 31, 2019. The former is below zero, while the latter is still above zero but trending lower.
Disclosure: Data sourced from Bloomberg LP. Recession dates defined by the National Bureau of Economic Research (NBER). The Cardan Aggregate Yield Curve Spread is the average spread between the following Treasury maturities: 3-year and 1-Year Treasury; the 5-year and 3-Year Treasury; the 5-year and 2-Year Treasury; the 5-year and 3-monthTreasury ; the 10-year and 2-Year Treasury; the 10-year and 1-Year Treasury; the 10-year and 3-month Treasury; and the 10-year and Fed Funds rate (i.e. central bank rate). The Cardan Recession Watch Line relies on economic indicators to detect if the overall US economy is weakening and approaching a potential recessionary period. It is an internal forecast only and not meant to be relied upon for consumer trading decisions.
Considering all of the volatility and conflicting news events and data sets, neither the Cardan Recession Signal nor the Cardan Volatility Signal have been triggered and they are still maintaining a risk on status. As neither is currently signaling, no allocation changes based on the signals have occurred.
The Recession Signal measures economic and market data. While monitored monthly, due to the infrequency of recessions, this signal is triggered only on average every five to seven years. Because of the depth and length of declines that recessions have on most asset prices, this signal applies to both taxable and tax-advantaged accounts across many of our portfolio strategies to provide downside protection. The signal contains several components including: bond spreads, business conditions, unemployment trends, and employment and market trends. Each of these act as pieces of a puzzle that, when put together, may show a picture of economic growth or economic contraction. Any individual piece in the table at a value of zero implies it is not currently signaling economic weakness. Conversely, a value greater than zero is a sign that a component is registering slowdown, and when multiple pieces begin to trigger (showing values greater than zero), the overall Recession Signal may be generated.
The Volatility Signal measures stock market volatility and instability in the bond market. This signal is also monitored monthly. Because the market’s tendency is to overreact to economic events that do not turn into recessions, this signal is triggered more often than the Recession Signal. Negative volatility events can be deep and persistent even outside of recessionary periods, enough to act on – but too frequent to do so in taxable accounts. This is why this signal will be used only in tax-advantaged accounts and not in taxable accounts, where tax considerations would likely outweigh the benefits of the signal.
The Fed’s 25bp rate cut in July was the first of this economic cycle. Strikingly, it occurred during a period of extremely low unemployment and some of the strongest economic numbers on record at the time of the cut. The preemptive move may put off recession and, in fact, spur growth again. The rate cut in tandem with the already falling long term rates of the government bond market, should help the consumer with home refinance opportunities and other consumer lending activities. But rates are not falling because things are rosy and the consumer appears to be one of the only pillars holding up the economy. An uptick in business capital expenditures would be welcome to round out any recovery. For now we continue to monitor the outlook, and will make changes to portfolios when our models dictate that the time is right. Feel free to reach out to any of us at any time to get clarification on any item mentioned here, or anything you have heard in the news. We are here to help and guide through these turbulent times.