Investments

Wage Inflation & A Volatile February

By Dean Barber

March 2, 2018

Well, I could be really sensational and say this is the worst February since 2009 and that’s true.

However, let’s get to the point of exactly what happened in February 2018, why it happened, and what to expect.

I will be releasing a State of the Markets video, which will be much longer, and going into much more detail. That will be coming out next week on our Education Center, right here at barberfinancialgroup.com.

So, we know that it was a bad February. We know there was a lot of volatility. Let’s take a look at what happened to the markets and talk a little about interest rates and why interest rates are such a big deal to the markets as a whole.

Index Performance

Chaikin Analytics – https://www.chaikinanalytics.com/

First, let’s look at the major indexes. If we look at the major indexes for the month of February, we noticed that the S&P 400 midcap was the worst performing sector coming in down 4.43% for the month of February. The Dow Jones Industrial Average was down 4.3%. The S&P 500 was down 3.64% and the NASDAQ was the big winner, only down 1.29%.

Chaikin Analytics – https://www.chaikinanalytics.com/

As we run this on a year-to-date basis it gets a little different look. You’ll notice that on a year-to-date basis we only have one sector that is actually in negative territory for the year and that is the S&P 400 MidCap. If we look at the NASDAQ, down only 1.29% in February, it’s actually up 7.35% on the year. The S&P 500 is at 1.79% year-to-date. The Dow Jones Industrial Average is up 1.2% and the Russell small-cap stocks are up 1.51%.

On a year-to-date basis, I think we have to be happy with that, but the question is, what in the world’s going on with all of the volatility in the stock market and why is it happening? We released a video mid-February to let you know what we’re thinking. First off, we see a lot of healthy things in the economy and I’ll go into more of that in the State of the Markets video that will be released next week.

There are a lot of healthy things in the economy right now, but there are two words that have not been uttered by the Federal Reserve in nearly two decades. Those two words are Wage Inflation, and that Wage Inflation is bringing fears of real inflation and we’ll talk a little bit about how that plays into the overall markets and why that’s such a big deal.

Interest Rates

U.S. Treasury – https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/Historic-Yield-Data-Visualization.aspx

Let’s turn our attention to interest rates, looking at what’s really happened with rates over the last couple of months, and taking it back to 2016. This is the yield curve on the 1 Month Treasury, 3 Month, 6 Month Treasury, etc. all the way up to the 10, 20, and 30 Year Treasury.

I want to focus on the 10 Year Treasury. On July 1, 2016, the 10 Year Treasury was at 1.46%, that was near a historical low. If we look at it today, that 10 Year Treasury is at 2.87%. So, we had a very significant increase in the 10 Year Treasury.

U.S. Treasury – https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/Historic-Yield-Data-Visualization.aspx

We’ve also seen a significant increase in the 1 Month Treasury, from 0.24% all the way up to 1.5%. Let’s bring that back into some more real times though because what I want you to understand is that from January of 2017 we really didn’t see that much of a shift. From January 2017, so that’s 14 months, the 10 Year Treasury increased from 2.45% to 2.87%. So, a very small increase on the 10 Year Treasury. Yet, you’ll see the 1 Month Treasury from .52% all the way up to 1.5%.

The Federal Reserve controls the short end of the yield curve. The Federal Reserve has raised rates four times now and we anticipate more interest rate hikes this year. That does not necessarily translate directly into the 10 Year Treasury yielding higher. Again, why is that a big deal? It’s a big deal for a number of reasons. Watch my State of the Markets address next week, because I’m going to talk in detail about what that treasury yield curve really means and why the market cares.

I don’t think we’re going to see this 10 Year Treasury just take off and all the sudden see a 4%, 5%, or 6% yield on the 10 Year Treasury. We’re going to struggle to get over 3% and definitely struggle to get over 3.5%.

I said in January 2015 I thought we would end the decade with the 10 Year Treasury somewhere between 2.5% and 3%. That’s still really possible, maybe we leak up a little bit over 3%, but I don’t think it’s going to be substantial. Let’s look at what this does to bonds because you’re hearing people talk about a bond bubble.

Interest Rates & Bonds

Kwanti  – https://kwanti.com/

I want to point out on this chart three things. First off, we’re looking from July 11, 2016, that was back when the yield on the 10 Year Treasury hit its all-time low, and this is coming up through February 28, 2018. The TLT is the blue line, this is the 20 Year Treasury. I want you to look at the return of the 20 Year Treasury, -14% since July 11, 2016. That is a big drop, that’s the bond bubble or the bond bear market that so many people are talking about.

If we look at the green line that is the iShares Core U.S. Aggregate Bond ETF, it’s a more diversified bond portfolio, and that is down just 2.16% over the same period of time. So, you have different maturity dates and you have different types of bonds there.

If we look at the orange line, this is PONDX or PIMCO Income Fund. The PIMCO Income Fund is a multi-sector bond fund, so they’re going to own some high yields, some floating rates, and things of the sort. Many of our clients will see that particular position in their portfolio. Over the same period of time where we’ve definitely seen interest rates increase, that PIMCO Income Fund is positive by 11.58%.

I bring that up because I don’t want you to fall into the trap of believing that all bonds are created equal because they absolutely are not. You’re going to have some bonds that will not react negatively to this rising interest rate environment. You don’t want to just go out and buy that long-term treasury right now though because that’s where you’re really going to get hurt

Let’s come back to why this is important and then I’m going to encourage you to watch out for our State of the Markets address next week where I’m going to go into some more detail on the Treasury.

If interest rates rise and you had the ability today to go out and buy a 10 Year Treasury at 7%, you’re a lot less interested in stocks. That’s one component of it, but there is a lot more behind it.

Let me say this about where we are today and what we’ve seen; if you went to sleep January 1st and you woke up at the end of February, most indices are slightly positive for the year some are up in the 7% range like the NASDAQ. What would you say? You would say, “Hey, looks like we’re off to a decent start of the Year.” There has been volatility, and I do expect the volatility to continue for some time, but I do not expect that this is the beginning of a full-blown bear Market.

Thanks so much for joining me I look forward to talking to you in our State of the Markets address next week.

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Dean Barber

Founder & CEO

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Investment advisory services offered through Barber Financial Group, Inc., an SEC Registered Investment Adviser.

The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.