Coming into the month we thought China trade would be a primary market driver, which it was, but we didn’t expect to see the yield on the benchmark 10-year Treasury note drop by 25% during the month, an extremely unusual event. Much of the talk this month was about the inverted yield curve, when the yield on the 10-year Treasury falls below the yield on the 2-year Treasury, and how that has predicted every recession for the past 50 years. However, the average lag time was nearly 2-years and the market advanced an average of 15% during that time. It is logical to say, if short term rates are higher than longer term rates, investors are indicating they expect the economy to slow. An additional catalyst this time might be the U.S. economy being one of the strongest in the world, so we have the highest interest rates. With interest rates in many parts of the world close to 0% it would make sense for money to be flooding into our 10-year Treasury notes, which would drive the yield lower and perhaps that is creating the inverse relationship. Regardless, recession fears weighed on the market for most of the month until a rally in the final days reduced the monthly loss on the S&P 500 to 1.8% and it is now 16.8% higher for the year.
The month got off to a rough start with a report that manufacturing activity had dropped to the lowest level since 2009 and President Trump’s announcing more tariffs on China. The S&P 500 was down 1.6% in the first 2 days. The first full week began with the Dow dropping 766 points, as the trade rhetoric heated up. It was a very volatile week as interest rates began to plunge, Trump said he was not ready to make a trade deal and Germany reported the worst year over year industrial production in a decade. The market moved at least 1%, in different directions, every day this week, but ended with the S&P 500 down just .5%. More volatility during the 2nd full week as the S&P 500 extended its number of consecutive days with a 1%+ move to 9. Plunging interest rates, increased rioting in Hong Kong and a heating up of the trade rhetoric were just some of the news. The week ended with good news on retail sales and stability in interest rates that help keep the S&P 500 keep the loss for the week to 1%. The 3rd full week of the month saw a 4th consecutive week of losses as concerns about a prolonged trade war with China sent the yield on the 10-year Treasury back to the lows for the year and China added more tariffs on U.S. goods. The market was in positive territory for much of the week ahead of a Trump tweet that turned a 100-point rally into a 500-point loss. The week ended with the S&P 500 shedding another 1.5%. Despite an expansion of the yield curve inversion, this week did have a better tone. On two occasions China made conciliatory trade comments and took steps to boost their own sagging economy. Many believe a trade agreement with China is an important part of reigniting a sagging global economy and better news on that front sent the S&P 2.8% higher this week.
September has historically been the worst month of the year for stocks, with an average loss of 1%. However, the month has closed with a gain 45% of the time and in 2013 it was one of the best months of the year. It appears the direction of the market, over the short term, is going to be dictated by the yield curve and perhaps, to a great extent, China trade. As we said last month, positive comments about a trade agreement with China tend to ignite a rally, while negative comments are greeted with selling. It is hard to imagine China granting concessions to anyone until they resolve things in Hong Kong. We have heard a lot of talk this month about recession, much of it politically motivated, and while recessions are a normal part of the economic cycle, predicting them is folly. The definition of a recession is 2 consecutive quarters of negative GDP and GDP grew at a +3% pace in Q1 and at a +2% pace in Q2. A recession is inevitable, but unless we get into a prolonged China trade war, is likely somewhere in 2021 or beyond. We continue to be a buyer on dips but believe it prudent to be cautious in September.
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