As a big guy, I usually get picked early any time there’s a game of tug of war — and I’ve had my fair share of pulling contests over the years. When the teams are well-matched, a good match can be a long-lasting, back-breaking, muscle-aching affair.
The U.S. economy is in a tug of war between growth and recession. There are positive factors that are pulling the economy toward growth, including low inflation, low interest rates, high employment, and growing corporate profits. The recession team is pulling with an inverted yield curve, declines in manufacturing, lower consumer confidence, trade war, and political drama.
When a tug of war lasts a long time, the contest becomes more psychological than physical. The key to winning one of these long-fought wars is to inspire your team to surge and pull rhythmically at the same time. When everyone surges in unison it breaks the hold on the other team, allowing momentum to be gained.
We’re still in the longest period of economic expansion since World War II. Now that this tug of war is 10 years old, investors are getting weary. There have been surges on the growth and recession sides over the past few years. Neither team has been able to break out and we have been stuck in a stalemate.
Slowing economic growth
Well, here’s where the analogy falls apart. Team growth never really wins, it just holds off a recession as long as it can. We believe team growth, while losing some ground, will be able to hold this as a stalemate for some time. U.S. economic growth has slowed to 2% from 3.1% in the most recent quarter. The economy would need to slip into negative territory for two consecutive quarters for a recession to be declared the winner.
What could get us to recession?
If a number of negative factors—consumer confidence, manufacturing, trade war, political drama, and increasing unemployment—all pull at once, we could head toward recession.
What would happen in a recession?
The last time recession prevailed in 2008, it was a blow out! The flag didn’t just pass onto the recession’s team side. The Great Recession dragged the whole economic growth team through the mud, all the way across the recession team’s end line. This latest war has gone on for a long time. Since the forces of growth and recession are equally matched so far, we don’t see any reason for a blowout. Blowouts usually occur when there are extreme asset bubbles, and we don’t see that scenario right now. We believe that if we slip into recession, it will be an exhausted pull of the flag across the line and not the result of some massive force overpowering the economy. Just as no two tug of war games are exactly alike, no two recessions are exactly alike.
Concerned that we are losing too much ground in this match, the Federal Reserve lowered interest rates in September for the second time this year. This appears to be a preemptive move by the Fed; a full third of the members disagreed with the recent rate cut. The Fed is reacting like it’s in a tug of war, too.
Because lower interest rates propelled the stock and bond markets higher this year, investors enjoyed nice returns. This is a positive outcome, yet it leaves us concerned about where returns will come from in the future.
The current low interest rate environment depresses the potential return from bond investments. Many bond investors, hungry for more yield, have accepted higher credit risks to achieve the returns they seek. This shrinks the extra compensation, or premium, bond investors earn for accepting credit risk. We don’t believe investors should accept risks for which they are not appropriately compensated. This is especially true in the bond market, where the upside is capped, and the downside is not.
The U.S. stock market has been one of the best performing in the world, and this is causing U.S. valuations to get a little stretched. We still see better valuations in foreign markets, and we continue to believe that our global diversification is a wise strategy.
Our investment committee has been busy looking at other ways to help diversify returns and reduce risk. We have increased our allocation to real estate investment trusts as a way to improve our portfolio diversification.
As we evaluate our portfolio allocations, we keep diversification and risk management as our team anchors. We need to be ready regardless how this latest economic tug of war plays out.
Please contact your advisor or me with any questions or concerns.
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Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
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