Our investment strategy team, with experienced investment representation from across all of our offices, is responsible for monitoring economic indicators and market metrics. Through a rigorous decision-making process, this team's efforts ultimately lead to a formal assessment of our outlook for economies, markets, valuations and interest rates. Here are two key questions raised by our investors as related to the current bull market:
Q: The Federal Reserve has raised its benchmark interest rate for the past 3 consecutive quarters. Why have bond and even mortgage rates fallen, albeit modestly, despite the Fed’s actions?
While the Fed recently raised its benchmark Fed Funds rate (what banks charge each other to borrow overnight) for the third time since last December, the yields, or current interest rates, on longer maturity Treasury Bonds have actually declined since the start of this year. This, in turn, has caused the difference between short term rates and longer term rates to narrow and create what is commonly referred to as a “flattening yield curve.”
Economists and other market watchers closely monitor the shape of the yield curve for what it is telling us about the economy. For instance, when the shape is inverted it means that current short-term interest rates are higher than long-term interest rates. The inversion can be an extremely reliable predictor of economic recession. However, a flattening yield curve like we are experiencing today is not as concerning. A flattening yield curve does not necessarily guarantee an inversion is on the immediate horizon. In fact, the level and direction of today’s yield curve is similar to that of the mid-1990s and mid-2000 bull market periods. Each period, though, is a bit unique. We believe the current environment can be interpreted as follows:
- While the Fed is signaling continued economic improvement in their actions to raise short-term rates, the markets are indicating lowered expectations of future inflation and economic growth.
- Declining longer-term rates are likely a reflection of the global nature of the bond markets. Continued accommodative polices by foreign central banks and lower rates in developed markets abroad make U.S. government debt relatively attractive. It would probably be more unusual if there were a greater difference between U.S. rates and other developed markets during this period of relatively strong U.S. economic conditions.
- Demographics may also be playing a role as aging investors in developed market could create increased demand for safer income-producing investments like bonds. Increased demand will push bond prices up and yields down.
The S&P 500 Index closed June with a positive return, making it the eighth consecutive month of positive returns. Many U.S. stock indexes have made new all-time highs in recent months with the support of strong market breadth, meaning 70% of the ten S&P 500 sectors have also made new all-time highs. This type of price momentum is typically bullish in the near-term and tends to carry market indexes higher over the next several months.
You might be interested in what history tells us about market streaks:
- As we headed into June, there were only 10 instances in which the S&P rose for seven consecutive months and, interestingly, it closed higher in the following 3-6 months every time. During the following 12 months, the S&P 500 closed higher in nearly 90% of the time with an average annual return of 12%.
- Since 1991, the S&P 500 has risen eight consecutive months only four times: 1996, 2007, 2011 and 2016.
- The S&P 500 has risen more than eight consecutive months only once - in 1995 for 10 consecutive months.
While the current price momentum and breadth is bullish for the next 6 to 12-month period, it is also very rare for these types of streaks to continue uninterrupted for this long. To put periods of market strength in perspective, it is helpful to look back at 2013 when the S&P 500 rose more than 30%, it also fell between 3% and 8% at six different points during the course of the year.
A 3-5% decline in the near future would be consistent with the historical pattern and should be expected at any point. But given the strong trend to this point and the mostly positive economic backdrop, any weakness is likely to be only temporary, debunking the inevitable media hype of the “end” of the bull market.