Welcome to the Monthly Economic Update, it’s May 1st as of writing this article so welcome to spring! I want to do a few things today. I want to talk about what is causing all of the volatility so far this year, what happened in April, and then I’ll give my outlook for the balance of the year.
It’s no secret that we’ve seen some extreme volatility creep back into the markets this year. Some of that volatility seemed to have subsided somewhat in the month of April. Yet, we did have several days where the volatility was still very apparent with some intraday swings at 500 and 600 points.
What is Causing All of the Volatility?
It’s a number of different things, but let’s start with the obvious, equity valuations. Equity valuations are high, and I’ve been talking about this for some period of time. You’ll hear me say equity valuations are high, and then you’re going to hear other people say they aren’t that high they are actually fairly valued. In fact, some would argue equity valuations are undervalued. I’ll tell you, it depends on how you look at things.
If you look at current interest rates that are still near historically low levels and look at market valuations compared to what interest rates are today; you could easily make the argument that, with interest rates as low as they are today, market valuations aren’t out of control. That would be a fair statement. However, if you just look at the price to earnings ratio (P/E) from a historical perspective, you would see that equity valuations are elevated. They’re elevated to higher levels than what we saw before the Great Recession and Great Depression, but still below the elevated levels we saw during the Dot Com Bubble.
So, a lot of the market volatility we see today is being driven by the talk of rising interest rates. We have an economy that seems to be firing on all cylinders. Housing looks great. We’re arguably at full employment. Corporate profits are off the charts, up 17-20% year over year. There are a lot of really good things happening in the economy. That’s leading the Federal Reserve to have a discussion about raising interest rates on a more rapid basis. That is what has the stock market spooked at the core level.
Every time the Fed talks about raising rates at a faster pace than what they were before you will see these wild gyrations in the market. Then President Trump making trade deals, talking about tariffs, or things of that nature which upset the market. The market doesn’t typically react to that type of news unless there are elevated values.
We follow three indicators: a short-term indicator, an intermediate indicator, and a long-term indicator. Our short-term indicator has turned negative twice this so far this year. Our intermediate, or quarterly trend, indicator is negative at the moment and will remain negative for the balance of this quarter. When this quarterly trend indicator is negative, 80% of the time since 2001, the markets have experienced a negative overall quarter. Obviously, that doesn’t mean this happens all the time, 20% of the time the markets still end up doing okay for that quarter.
Where are we at right now? Where do we think the year is going to go? Let’s take a look at the dynamics in the major indices so far this year.
What we’re looking at in the first chart is a year to date chart of all of the major indices. The NASDAQ composite is up 3.33% as the best performer so far this year. We can see in the second chart the NASDAQ at one point in January was up as much as 12%. The Dow Jones Industrial Average, which was the darling of last year, is actually the worst performing major index so far this year and is down -2.36%. The S&P 500 is off by -0.88% year to date.
As you can see in that first chart there is a lot of red year to date, but nothing big or earth-shattering where you should say, “Oh my gosh I’m going to run for the hills.” However, if you were to look at it in comparison to the highs of where we were in January of this year it’s been a pretty big pullback since them. The question becomes, does that pull back continue or do we get some stability and start seeing some growth?
My sense is that we will have more volatility in the short-term ahead. Who knows what the future will bring for sure, but I think there’s more volatility. We will have to keep an eye on what goes on with interest rates, foreign trade, and a number of domestic economic policies that are being talked about right now.
Equity valuations are elevated and we’re almost to one of the longest expansions of a bull market in history. You’ve heard me say this before, every single bull market is followed by a bear market. It’s not a question of if, it’s a question of when. We have to be diligent and err on the side of caution.
If we take a look at the indices for just the month of April in the above chart we see every index was positive. Again, the NASDAQ was the best performer and Dow Jones Industrial Average was the worst performing for the month.
If we take a look at the specific sectors on a year to date basis in the chart above, we can see that Consumer Discretionary is winning big time being up 5.08%. At the bottom of the heap, we can see Utilities, Industrials, Materials, and Real Estate. Real Estate is at the bottom because it is such an interest rate sensitive type of investment. Higher interest rates can harm the value of Real Estate and that’s why you’re seeing Real Estate as one of the most hard-hit sectors so far this year.
Above is the Treasury Yield Curve with the blue line being where the yields were on January 1, 2018, and the green line is the yields as of May 1, 2018. The One-Month Treasury on January 1st was 1.29%. and today it sits at 1.68%. We actually saw a rise almost consistently across the board. As you can see the 10 Year Treasury on January 1st was at 2.46% and is up to 2.97% as of May 1st. The 10 Year Treasury did creep over that 3% mark in April but has come back down under that amount again. Even the 30 Year Treasury started the year at 2.81% and is up to 3.13% as of May 1st.
If we look at this comparing January 1, 2017, to today above, you can see a big difference in the blue line. The 10 Year Treasury on January 1, 2017, was at 2.45% so almost the same as it was this year, January 1, 2018 at 2.46%, and today we’re at 2.97%. So the change over that 16 month period was not nearly as great as the yield on the One-Month Treasury which began 2017 at 0.52% and is sitting at 1.68% as of May 1, 2018.
The big fear is all around the right end of the chart, the 10, 20, and 30 Year Treasuries. The worry is that they’ll affect mortgages, longer-term certificates of deposit, and that harming the economy. It also could entice people to take money out of the stock or bond market where they have perceived risk and putting that money in more safe options like treasuries or certificates of deposit.
A lot of the volatility we are seeing in the market is due to the chart above, it’s due to the rise in interest rates. We’re not done with the rising interest rates yet. One of the things I’d like you to notice is from early 2017 on from the One Month Treasury to the 30 Year Treasury you can see the blue line goes on a very sharp curve. This is a sharp yield curve with low rates on the short-end and higher rates on the long end. Compared to today, the green line, where you can see we have a very flat yield curve.
My best guess on what’s going to happen with treasuries is that you’re going to see that short-end of that yield curve, from the One Month Treasury to the 5 Year Treasury, continue to rise more rapidly than the longer-term rates on the right side of the chart. The reason I think that’s the case is that even though the economy seems to be doing well, we’re not seeing money velocity coming back into play yet. I think it’s around the corner, and if you’ve heard me talk about this and have listened to me in the past, I’ve said that I think that around 2019 or 2020 we would start to see that money velocity start to pick up. When it does pick up, that’s going to mean higher inflation causing the Fed to get more aggressive.
Bottom line, we have a scenario where we have rising interest rates, that’s happening, and more rate hikes are coming. I think the rise in the longer-term treasuries is going to be much slower than on the shorter-term treasuries. We have equity markets that are overvalued, and they can trade in an overvalued range for a long period of time. So, it doesn’t necessarily mean they are coming down right away. Currently, our intermediate indicator is in the negative territory, but both the short-term and long-term are positive. The long-term indicator has been positive for quite some time, and the short-term has gone back and forth with all of the volatility between positive and negative so far this year.
I don’t know exactly where we are going to end up this year. What I would prepare you for is more volatility in the market. We have taken a number of steps here at Barber Financial Group to help mitigate this risk and we are always going to err on the side of caution. We want to be opportunistic and we want to make money when it’s prudent and when the time is right. However, we understand and respect the fact that your money is important to you and we want to make sure we are doing everything we can to keep that money safe.
I encourage you to keep an open line of communication with your advisors hear at Barber Financial Group, and always feel free to give us a call at 913-393-1000 and check in with us whenever you want to do so. Make sure the plans we have in place for you are still consistent with where you are today. As always, our objective here at Barber Financial Group is to help you live your one best financial life by providing you with clarity, confidence, and control.
Even you aren’t a client of Barber Financial Group we’re here to help. If you have any questions regarding your finances and the recent volatility or if you just want a to have a chat with one of our advisors to get a second opinion on your retirement, reach out to us anytime at 913-393-1000 or fill out the form below and a Barber Financial Group Advisor will be in contact with you.
Until next month, I thank you for your time.
Founder & CEO
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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.