By Tim Courtney, Chief Investment Officer
Markets continue to hit all-time highs with the S&P 500 recording just three negative months (and those only slightly negative) in the past 15.1 Naturally, some investors are beginning to wonder if this ongoing run-up is too good to be true.
While most signals continue pointing to strength, recently falling interest rates have captured the market’s attention as a potential warning sign. Over the last three months, the U.S. 10-Year Treasury yield dropped from 1.75% to about 1.30%.2 This rapid decline has some concerned because falling rates may indicate slowing demand for loans, investors looking for safety and a slowdown in overall economic growth.
Falling rates though are not always a reliable harbinger of weakness ahead. Just a few years ago, in late 2018, interest rates fell and the yield curve became inverted, a sign of nearing recession. The stock market became spooked and fell almost 20%.3 But it turned out to be a false signal. By early 2019, it was clear that growth was continuing and the market recouped its losses by mid-April and was up about 30% for the year.4
It’s too early to tell just what these falling rates mean. Some people believe interest rates are being pushed down by a proliferation of foreign buyers. Investors in Germany or Japan, where interest rates are at zero,5 may find a 1.5% yield in the U.S. very attractive. This is probably happening to at least some degree. The Federal Reserve has also been very active in markets and is also likely affecting rate movements.
Interestingly, falling rates have occurred at the same time that inflation numbers have risen to their highest readings in over a decade, and several future expected inflation measures have been rising.6 Inflation may, as some have suggested, begin falling in the quarters ahead as growth moderates. However, there still appears to be a lot of momentum in the system with gross domestic product (GDP) up at an annual rate of 6.4% for the first quarter.7 Consumer confidence is also growing with relatively high cash and savings balances, and companies are seeing spending and growth translate into record-breaking earnings.8
Either rapidly falling rates or accelerating inflation numbers could be a candidate for sparking a normal correction. As we’ve noted before, we are not forecasting a market pullback but we also shouldn’t be surprised if we see one since they historically happen about once every year-and-a-half.9 This goes with the territory of being a stock investor and is the reason why stocks have historically had higher expected returns.
We still think the momentum within the financial systems will create higher than average growth into 2022. While we look at market pricing signals to get a better understanding of the economic environment, signals can sometimes simply be market noise and this may be the case today as investors adapt to reopening economies. We’re continuing to watch these numbers to help inform our strategy investment decisions.
- Yahoo! Finance (4/16/20 to 7/16/21) — S&P 500
2. MarketWatch (4/16/21 to 7/16/21) — U.S. 10 Year Treasury Note
3. Bloomberg (12/4/18) — Tumbling stocks show you can’t ignore the ‘harbinger of doom’
4. CNBC (12/31/19) — Stocks post best annual gain in 6 years with the S&P 500 surging more than 28%
5. Financial Times (9/3/19) — Will the US follow Germany and Japan below zero?
6. CNBC (7/12/21) – Inflation expectations surge, hitting new high for New York Fed survey
7. The Hill (6/24/21) — Economy grew at 6.4 percent yearly pace in first quarter of 2021
8. Yahoo! Finance (4/30/21) — Earnings are beating expectations at a record rate
9. Grow (Bespoke Investment Group) (2/13/18) — How often do stock market corrections happen?
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
The 10-year Treasury note is a debt obligation issued by the United States government with a
maturity of 10 years upon initial issuance. A 10-year Treasury note pays interest at a fixed rate
once every six months and pays the face value to the holder at maturity. The U.S. government
partially funds itself by issuing 10-year Treasury notes.
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