On August 14th, the 10 year Treasury Yield went slightly below the yield for the 2 year Treasury, the first time this has happened since 2007. Economist pay close attention to the 10 year vs. 2 year Treasury yields, as its historically been a strong predictor that a downturn is on the way. The yield curve has inverted before every US recession since 1955, although it sometimes happens months or years before the recession starts. The average time between the last 5 yield curve inversions and a recession was 17 months. This lead time is the key and its still very uncertain how long a lead time we may have in the current economy before there is an actual recession. That said, an inverted yield curve, like most other indicators, is not perfect and doesn’t mean a recession is imminent.
On Christmas Eve it looked like the bull market was over, with the market down nearly 20% in less than a quarter. Now, 6 months later, we are back at all-time highs and the market has rallied over 26%. While the average investor is left scratching his or her head, the rally is the result of one main catalyst, the Federal Reserve’s desire to keep interest rates low. This is not a new phenomenon, as the low interest rates have been a driver of much of the market’s success over the past decade.
As we write this letter and reflect back on the past few weeks, the word that keeps coming to mind is REDEMPTION. Just like the Virginia Cavaliers basketball team in the National Championship and Tiger Woods at The Masters, the market has had the ultimate bounce back story: falling 20% the last few months of 2018 to up over 16% for the year as of the writing of this letter. Despite this bounce back, the risks initially associated with the steep decline in 2018 are still very much there, and until we have a clear signal telling us otherwise, we will remain with a more defensive posture. After all, it was the defense by Virginia and the safe play of Tiger Woods that won them championships.
Just as the government shutdown ended, the IRS kicked-off its’ 2019 tax filing season this week on Monday, January 28th. With the window now open to file returns, we would like to draw your attention to the new postcard-sized 1040…and why it may not be as simple as it seems.
What a difference a year makes! The largest drop in 2017 was less than 3%, while 2018 experienced the largest drop since 2009 at nearly 20%. In 2017, December saw near record highs while December of 2018 was the worst on record (except 1931, The Great Depression); Christmas Eve was the worst in history. Stocks were not the only problem investment: nearly every major asset class was negative for the year with the exception of the aggregate bond index which was up 0.01%. The chart below shows that among the eight largest asset classes, none gained more than 5% for the first time since 1972 (see chart below). 2018 was a major anomaly and will go down in history as a tough year for investors.