Tariff jitters and preparing for eventual slowdown
The first week of December was an exhausting one for investors, even though there were only four trading sessions.
It began right after the G-20 Summit, when the United States and China announced a 90-day trade war time out. While all current tariffs will remain in place, the U.S. will not raise the rate from 10 percent to 25 percent on $200 billion worth of Chinese imports, which was slated to occur Jan. 1. The news was received well and investors pushed up stock indexes.
But the euphoria wore off 24 hours later, after President Trump tweeted that he is a “tariff man,” followed by another in which he questioned whether a “real deal” with Beijing is possible. Investors ran for the hills, pushing down stock indexes by 3 to 4 percent.
Trade tensions between the world’s two largest economies escalated after the arrest of Huawei Technologies’ chief financial officer Meng Wanzhou on allegations that she violated U.S. sanctions against Iran.
All of these events come amid a nagging anxiety about a global growth slowdown. One sign of that tension was seen in the bond market.
Let’s start with some basics. Typically, it should cost less to borrow for shorter periods of time than longer ones. So when you buy a 10-year government bond, the interest rate is normally higher than when you buy a two-year (the difference between those two interest rates is known as the “spread”).
You get paid more for a longer term because a lot can happen in the future, most notably, inflation can eat away at your fixed bond payments. Therefore, bond buyers usually demand higher rates to compensate them for the additional risk of holding the asset for a longer time period.
When you plot interest rates on a graph, a normal yield curve will slope up; the steeper the slope, the more that investors think that inflation and interest rates will rise in the future. When investors believe that growth is slowing and that the rate of inflation will be tepid in the future, the yield curve flattens out. That’s kind of where we are right now.
But, when short-term rates are higher than long-term rates, the curve inverts, meaning that it slopes down. Here’s the hair-on-fire part: Every U.S. recession for the past 60 years followed an inverted yield curve, though sometimes not until months or even years later.
In early December, the gap between three- and five-year government bond yields dropped below zero for the first time since 2007 and the spread between two and ten year bonds, the most important relationship to investors, decreased to 0.11 percent, the narrowest since 2007. That’s not technically inverted, but it got already freaked out investors even more freaked out.
Before you rush to the exit and sell every stock or stock mutual fund that you own, remember that you are a long-term investor who is not going to fall for the age-old trap of thinking you can time the market. Instead, remind yourself that you do not need to figure out when the next recession is coming, but you do need to have adequate emergency reserves and a diversified portfolio that will allow you to sleep at night when the eventual slowdown occurs.
Let the so-called experts try to predict whether current stock valuations are too high, relative to the ability of companies to make money in amid a slower growth environment, while you enjoy a stronger batch of eggnog this holiday season.
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