Family office investors monitor a variety of economic data on an ongoing basis to understand how the markets are evolving. In addition, they know that the market itself is a signal. Since Christmas Eve, the US stock market has rebounded sharply. All of this rebounding has been a result of expanding valuation multiples, indicating that stock investors feel better about company prospects today than they did four months ago.
S&P 500 price to earnings ratio
We think this is a powerful signal as the pooled decision making of millions of participants should not be discounted. In addition, the Federal Reserve is pursuing a more accommodative monetary policy and the Chinese government is pursuing stimulus measures for its economy. So there are some good fundamental reasons for investor optimism. Current valuation levels are, however, high relative to their history, and investors need future growth to be quite strong to validate the price they pay today for stocks.
S&P 500 price to earnings ratio
Buying stocks today is an explicit wager that the global economy will not only avoid a recession during the next few years but also that the current pace of economic activity picks up. Unfortunately for investors, professional forecasters have been quite poor at predicting a recession. In fact, forecasters missed the great recession even months before its onset.
Economic forecasters seldom predict a recession
However, for the same reason that investors should give credence to the collective decision making of stock investors, we believe investors should also carefully assess the signals the bond market is providing. Longer term bond yields have fallen throughout 2019, with the US Treasury 10-year yield currently just below 2.4%. Typically long-term yields rise when investors’ growth expectations rise and fall when investors become more cautious. The yield curve recently inverted, meaning that the yield on 10-year Treasuries is lower than the yield on the 3-month treasury bill. An inverted yield curve has historically been an important signal of future economic difficulties.
Yield curve inversion has happened before prior recessions (shaded pink)
In addition, the NY FED recession predictor model, which is based upon the interest rate environment, is showing the highest probability of recession since the Great Recession of 2008.
The probability of a recession in the near future has increased
We think all investors should be cautious when two important market signals that incorporate the financial decisions of millions of investors point to different outcomes. At current valuations, the stock market needs the good times to continue and the bond market is casting doubt on that scenario. This is a good time to review your stock exposure, and take steps to reduce risk in stocks where your conviction about future growth is not high . Family office investors know that the key to weathering bouts of market volatility is focusing on securities that you are confident in owning for the long term.
Past performance is no guarantee of future results. This article was prepared by Choate Investment Advisors LLC (“ChoateIA”), a subsidiary of Choate, Hall & Stewart LLP. ChoateIA is registered as an investment advisor with the Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about the firm can be found in its Form ADV Part 2, which is available upon request by emailing email@example.com.
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The opinions expressed are solely those of ChoateIA. The information contained in this article has been obtained and derived from publicly available sources believed to be reliable, but ChoateIA cannot guarantee the accuracy or completeness of the information.