Given all the volatility in rates and equity markets, we thought it might be a good idea to give you a quick update.
Since we last wrote about markets in our April commentary, a lot of things have happened or changed:
As the result of this, the Federal Reserve is now expected, by market participants, to cut rates at least 2 times this year. The big question is no longer if, but when that will happen. Some speculate that it could happen as soon as the July FOMC meeting. In a speech yesterday at a Fed event, Chairman Powell said that the FOMC would assess the impact of those trade developments and act in such a way as to extend the economic cycle as long as possible (i.e. cut rates if the outlook deteriorates). This hints that they want to see what happens (at the very least at the G20 summit late June) before making a move. We do not think that the Fed wants to cut rates too early, but it might become a necessity. Unfortunately, vindicating Trump’s recklessness.
The bond market has reacted quickly to all the above.The yield curve is now inverted by more than 20bps. Based on our recession model, this implies a 46% chance of a recession in the US 12 months from now. Of course this is simply a model, but it goes to show how quickly things have deteriorated.
Source: Ninepoint Partners
In this context, it still feels like equities and credit are living in a fantasy, acting as if a Fed rate cut is good for them. We strongly disagree. The Fed cuts rates because the economy is deteriorating, which is bad for earnings and multiples. Accordingly, previous historical episodes of rate cuts are associated with low equity returns and double the usual volatility.
From a portfolio positioning perspective we are preparing for the slowdown and potential of 2020 recession. We have continued to high grade the portfolio, sell down lower rated credit, add government bonds and extend duration.
As always, please reach out to us with any questions or comments. Happy to expand on topics of particular concern/interest.
The Bond Team: Mark, Etienne and Chris
1 All returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at April 31, 2019; e) 2010 annual returns are from 08/05/10 to 12/31/10.
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