Hello ConCappers,
As you have probably seen in the news, the Dow and the S&P 500 were both down about 6% yesterday from their highs in mid-July. Although there was a nice rebound yesterday and today, August has generally never been a good month historically (since 1945 the average return in the month of August has been a paltry 0.2%1). So, we want you to keep a few things in mind so that you are informed with what is happening with the underlying state of the market and the economy in general.
The sell-off this past Monday was precipitated by China devaluing its currency. Although China hasn’t made such a move in a while, the move was unexpected and undoubtedly in response to the fresh round of tariffs from the Trump administration. At the same time, long-term Treasury yields have plummeted causing the already inverted yield curve to become even more so, which has historically been a classic sign of a recession. But all of this needs to be taken into context. We will attempt to break this down some more ahead:
China Trade War
The Chinese economy has been overheating for a while now and there has been discussion of a vast credit bubble that will probably have dire consequences at some point. In 2017, China\’s debt-to-GDP ratio was at 266%, one of the highest in the world, and is forecasted to continue growing at a staggering rate, especially given its controversial shadow-banking practices.2 It\’s also largely an export-driven economy as nearly 40-60% of their GDP growth comes from exporting to its trading partners.3
In contrast, the United States is largely much less dependent upon its trading partners, like China, for growth and seems to be the oasis in the desert of otherwise hurting economies elsewhere. For some context, Apple, for example, gets only 10-12% of its revenue from China.4 Facebook has been blocked in China since 2009, and Google ended operations in China in 2015.
It must be seen that China has much more to lose in this trade war than the U.S., at least for now.
Inverted Yield Curve
In short, an inverted yield curve is an interest rate environment where the long-term yield is less than the short-term yield. Normally, but not always, this has been a classic indication of a recession to come. Keep in mind, we are now in the longest bull market in our history, so if a recession were to come, it would be well overdue. Certainly, the longer the curve stays inverted the greater chance of a recession.
There is compelling evidence that we are close to a recession or already in the early stages of one. The question regarding the recent volatility is whether there is a legitimate recession on our hands or just greater momentary uncertainty. The only way to know this is to see how company earnings will fare in the next couple of quarters.
The good news is that, in the meantime, there may be opportunities to buy at a discount. Regardless of what happens in the near-term, it is difficult to time the market and our focus will remain on the long-term investment strategy while paying little attention to the noise.
Thanks,
VJ Arjan, CFP®, ChFC®
CEO
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