Dear Clients & Friends,
It’s the time of the month for monthly risk update for which we turn to our good friend Brad McMillan.
Once per month, we share Brad’s thoughts on the markets. This month, we are going to share slightly different research elements that pertain more so to the economy in general. As we know, perception regarding the economy influences the market very much. However, the economy and the investment markets are not directly correlated to each other. Human emotion is part of what drives the market, and public perception of the economy influences human emotion. Therefore, they are highly correlated over long periods of time, but they are not perfectly correlated; and in the short run, sometimes they are not correlated at all. This can be especially noticeable when news sources pick and choose which facts to share with their partisan audiences, and certain politicians attempt to window-dress reality.
With this in mind, we are substituting an economic risk update for our monthly market risk update. With that preface, Brad, take it away…
Although there was some good news last month—job growth bounced back to come in well above expectations—the overall trend remains negative. Confidence has continued to decline, while the yield curve hit an official inversion as of the end of June. That said, conditions remain generally favorable, with all metrics in expansionary territory except the yield curve, but there is no doubt the risk level has risen further. That risk still does not look immediate, but that point may be getting closer.
The Service Sector
Signal: Yellow light
As a representative sample of the largest sector of business, this is an important leading indicator. It fell back again last month, taking it close to the lowest level in almost two years. In addition, the manufacturing index continues to weaken, which adds color to this reading. Although the risk level remains elevated as these indices decline, conditions remain expansionary, at least for the moment. As such, we are keeping this indicator at a yellow light.
Private Employment: Annual Change
Signal: Green light
With a significant recovery in June job growth, private employment growth stabilized on a year-on-year basis. Although it remains at healthy levels (at or above those of the mid-2000s), the growth rate has declined consistently so far in 2019, suggesting that the decline in the growth rate is now an established trend. If this trend holds, it will eventually take us to a risk level—but we are not there yet. Because this is an annual figure, the changes are slower and smaller than those we see in more frequently reported data.
Private Employment: Monthly Change
Signal: Yellow light
These are the same numbers as in the previous chart but on a month-to-month basis, which can provide a better short-term signal.
After a weak May, June’s job creation bounced back, suggesting that growth continues despite a couple of weak months this year. That said, the monthly results have been meaningfully weaker in 2019 than in previous years, which provides further evidence that growth is slowing. The volatility of the monthly results, along with more frequent weakness, is an indicator that job growth may be weakening. As such, I am keeping this indicator at a yellow light.
Yield Curve (10-Year Minus 3-Month Treasury Rates)
Signal: Yellow light (tending to red)
Rates closed last month at the first full inversion since before the financial crisis, which historically has been a sign of a pending recession sometime in the next couple of years. This indicator has, however, generated false signals in the past and is not infallible. Given that, and the likely lag before a recession, we are keeping this indicator at yellow shading to red for the moment. Although an inversion is a good signal of pending risk, the better signal for immediate concern has been when the curve un-inverts, typically due to rate cuts, and that will likely be the point at which we take this indicator to a full red.
Consumer Confidence: Annual Change
Signal: Yellow light
Confidence dropped again in June, taking it further away from recent highs and moving the year-on-year change meaningfully below the zero level. Although it remains above problematic levels, it is getting close, and another bad month could conceivably get us there. The absolute level of confidence remains high by historical standards, but the annual change suggests that risks continue to rise. As such, we are leaving it at a yellow light.
Conclusion: Risk remains elevated
Despite a recovery in job growth, signs of weakness continue to multiply. Both consumer and business confidence were down meaningfully, and the inversion of the yield curve is now official. These results suggest that although current conditions remain favorable, risks are increasing. The risk factors remain outside of the red zone, but some are getting quite close.
Although a continued slowdown remains the most likely case based on the data, a slowdown is not a recession—we likely still have several quarters to go there. Nonetheless, the bulk of the data indicates the risks of a worsening slowdown remain material (again, not yet as the base case). As such, I am leaving the overall risk level at a yellow light for the economy as a whole for July.
So, there you have it. The markets continue to rise and set another new high a few days ago. We believe that the market will continue to rise over the remainder of the year. However, we remain cautious because we still expect a shift in trajectory in the coming months, and a recession to set in next year.
Have a lovely weekend.
Matthew Ramer, AIF® Principal, Financial Advisor MOR Wealth Management, LLC
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The majority of this content was written and distributed MOR Wealth Management, all rights reserved. Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a registered investment adviser. Fixed insurance products and services offered through CES Insurance Agency.
Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a registered investment adviser. Fixed insurance products and services offered through CES Insurance Agency. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. As stated above, commentary for the 5 risk factors provided by Brad McMillan and published in the Independent Market Observer. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. The S and P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index. The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.