In both cases, the reactions were strong because the cut in the benchmark rate was less than expected. In addition, the trade war with China could directly impact American consumers, even though the value of the new tariffs ($30 billion) is relatively low compared with the total value of the U.S. economy ($20 trillion).
Another key factor for investors: the yield curve in the United States is inverted, which means that the yield on 10-year Treasuries is lower than the yield on 2-year notes. Such an inversion can signal a recession, although most often it is a signal from the stock market that the central bank must act to lower its benchmark rate to avoid a recession.
Is the risk of recession real?
Although indicators may suggest that a recession is imminent, it could be avoided by proactive central bank intervention.
Aware of the danger, the Fed, like most central banks, has already begun a new monetary easing cycle and the market is hoping for a 1% reduction in the benchmark rate within one year. We will see at the next Fed meeting in September if another rate cut is announced. If so, the 2-year yield could once again fall below the 10-year yield, which would allow the economic cycle to continue.
Moreover, did you know that the current economic cycle is unusually long by historical standards? In terms of economic growth, however, it has been one of the weakest. At present, there are no indicators pointing to a recession, such as a technology bubble or a shaky credit market.
A changing economy
The foundations of the American economy have certainly changed: today, the services sector generates more than two thirds of U.S. GDP, outstripping by far the manufacturing sector (11%). Since employment is currently at a high in the United States and since wages are growing, the risk of a recession is relatively low. But the trade war between Washington and Beijing, in addition to threatening the manufacturing sector of many countries, could have repercussions on global growth and, consequently, U.S. growth. A reduction in the benchmark rate by global central banks should mitigate this risk.
What are the stock market risks?
Although the U.S. stock market hit a high on July 26, many indicators have fallen since. Corporate earnings growth was stronger than expected in the second quarter, but the cumulative annual growth rate has slowed.
In terms of investments, the dividend yield is much more attractive than bond yields. With the recent decline in interest rates, investors will have to turn to stocks to obtain a return. In the current environment, many will be tempted to review their investment policy and make changes to their portfolio. However, caution is in order: no decision should be made without first speaking with your advisor for a more in-depth analysis of the repercussions that such changes could have.
What are we doing to manage risk and generate returns in your portfolio?
As you know, our investment experts are monitoring the situation very closely and making the necessary adjustments to minimize risk and protect your assets.
That’s why, several months ago, we reduced the weight of higher-risk bonds and stocks in our Private Management approaches.
We also reduced the weight of equities in our FDP Tactical Asset Allocation Private Portfolio and adjusted the choice of securities by opting for lower volatility investments.
Note that our FDP Alternative Strategies Private Portfolio, whose strategies are uncorrelated with equity and bond strategies, delivered a positive return during this period, thus showing its value in a diversified portfolio in times of market turbulence.
We continue to favour quality investments, in businesses that have low debt and a sustainable earnings and dividend growth profile. The relative performance of our funds in August, and year to date, clearly shows our ability to successfully navigate troubled waters.
- Risks remain and they are numerous.
- A recession will be avoided by proactive central bank intervention.
- The decline in interest rates and the equity market correction are creating stock market opportunities.
- Quality, dividend-paying growth stocks remain an attractive long-term investment and an alternative to low yields.
- For investors, there are few alternatives to stocks when rates are so low.
- Geopolitics directly affects the markets, including the many tweets of President Trump.
- We are making every effort to make the necessary adjustments in order to minimize risk and protect your assets.
That said, in these turbulent times, rest assured that we are keeping a close eye on current market developments. As always, your advisor is your resource person for everything concerning your portfolio. Don’t hesitate to contact him for any questions concerning your situation, your risk tolerance or your investment policy.
Vice-President and Chief Investment Office