"Kee" Points with Jim Kee, Ph.D.

Quick Thoughts on What’s Ahead

Trade concerns, slowing growth, and an inverted yield curve with historically low global interest rates have been the evolving story over the past year. But as Credit Suisse strategist Jonathan Golub points out, that is why US market returns have been “flattish” over the past 12 months. The next twelve months will depend not upon things that have occurred, but on things that have yet to occur.

On trade, I tend to agree with economist Victor Canto (La Jolla Economics), that “the US beef with China should be the technology ‘transfer’ issue, not the currency manipulation or the trade balance.” If President Trump’s focus narrows to that, then I think the markets will respond positively. The G20 or Group of Twenty countries have recently acknowledged that the World Trade Organization is in need of reform, particularly its trade dispute settlement policies, which is where the technology transfer issues fall. Of course, enforcement is always a stumbling block with international agreements, whether they are about weapons, environmental concerns, human rights, or trade. Nobody expects perfection on the trade front here, just incremental improvements. I continue to think that is a reasonable expectation.

On the inverted yield curve, any “recession” signal is seriously distorted by things influencing long-term rates, like negative rates internationally, the global safe-haven status of US treasuries, and automated program trading by banks and insurance companies (WSJ). Futures markets imply a steepening of the yield curve, with five rate cuts (i.e. lower short-term rates) expected by year-end 2020, and a slight uptick in 10-year treasury yields expected over the same period (Credit Suisse). Most strategists point out that low bond yields continue to make stocks attractive, as 8 of the 11 broad stock market sectors have a dividend yield that exceeds the 10-year US treasury yield. Indeed, simple dividend-discount models (e.g. the Gordon Growth Model) point to higher valuation levels (Credit Suisse).

Interestingly, the US Treasury Department has shown some interest in issuing (or looking at issuing) 50-year or even 100-year bonds. As an economist, my first thought was, “of course they should,” and “why not issue perpetuities?” Many of my fellow economists agree. For a great (longer than I can do here!) read on this topic, see University of Chicago economist John Cochrane’s blog, The Grumpy Economist.

As for economic growth, current expectations are for 2% growth in the US. A lot of data like labor market data, housing data, loan performance data, etc., just aren’t signaling recession. The current expansion is the longest (and slowest) ever, perhaps somewhat attributable to the growing share of services (less cyclical) and the declining share of manufacturing (more cyclical) as a percentage of GDP. Global growth seems to have stabilized somewhat, though it remains particularly challenged in Europe (Credit Suisse). I still expect China to ultimately back off of Hong Kong (for now, anyway), but so far that prediction has been wrong. We’ll see what the next few months hold.

Advice: As for the recent uptick in stock market volatility, try to remember that volatility has little meaning for investors in the sense of actionable strategies. That comes from the world’s experts on the subject (William Schwert and Elroy Dimson). Remember that market valuations within a range of, say, 5%-10% (which I regularly expect), amount to a range of movement (up and down) of 1300-2600 points on the Dow. Remind yourself that your horizon with equities is multi-year, not the press’s obsession with the next data release. If you still have concerns, consider adjusting your stock-bond allocation, but avoid all-or-nothing (completely in or out of stocks or bonds) thinking at all costs!