The yield curve narrowed continuously throughout most of 2018. The spread between 2- and 10-year Treasuries fell to just over 9 basis points in December and sits at 14 now. Where is it headed? The answer is likely towards an inversion. The Fed is releasing its minutes, and once it does, it seems likely the spread will continue to narrow. There are two scenarios that would likely create an inversion. The first is if the Fed minutes show that the central bank may raise rates again soon (sending short term yields higher). The other, and perhaps more likely, scenario is that the Fed expresses some anxiety about a recession (pushing long-term yields lower).
FINSUM: This is interesting because the two most likely scenarios for what the Fed might say/do in the near-term both add up to the same thing—a yield curve inversion.
The recession has loomed over markets for months. However, in recent weeks those worries have faded a bit, especially as the Fed appeared to back off the gas pedal on rate hikes. However, a new survey from Bank of America Merrill Lynch shows that recession is the top fear among investors currently. A third of credit investors surveyed see a recession as their top fear. That is the highest level for a single worry in almost two years. Economic data is expected to continue to weaken, say investors.
FINSUM: The US seems to once again be the last one standing as the whole world starts to slow. Can we hold up yet again?
We think we might have found an area when Democrats and Republicans might agree. Here is an interesting argument—Fannie Mae and Freddie Mac distort the housing market and negatively affect renters. This is a conclusion from the Wall Street Journal, which found that the subsidized loans from the agencies artificially lowered interest rates on multi-family properties (apartment buildings), which helped developers in acquiring them. The developers then go on to raise rents. In some cases, owners of big units refinance using agency mortgages and are therefore rewarded for raising rents.
FINSUM: From the left’s view, this hurts everyday Americans by raising rent prices. From the right’s view, this is an example of how big government distorts the economy. All that said, in single family housing, the agencies still seem to have benefits that outweigh their negatives.
As our readers will know, we spent the better part of last week at the Inside ETFs conference. As part of our time there, we are planning to feature a couple of ETFs which we think might be interesting to advisors. The first one we want to feature is a special fund from Legg Mason, the fund is called the Legg Mason Low Volatility High Dividend ETF (LVHD). We were lucky enough to meet with one of the fund’s specialists, Josh Greco, at the conference, and his passion for the fund’s approach really shined through. The fund’s own words describe it best, it seeks to track “the investment results of an underlying index composed of equity securities of U.S. companies with relatively high yield and low price and earnings volatility … LVHD may benefit investors who want income but are concerned about the volatility that can come from traditional equity income investments”. Basically, the idea is to get yield and upside, without so much of the volatility that is traditionally associated with equities. Mr. Greco contextualized the utility of the approach succinctly and convincingly, explaining that as clients’ lives elongate they are going to need to stay in equities longer to get capital appreciation. Accordingly, this fund seeks to de-risk some of that necessary exposure while still giving significant upside and yield. The fund has about $600m in AUM, is widely available, has an expense ratio of 0.27%, and a dividend yield of 3.48%.
FINSUM: In our mind, this fund does an excellent job of fusing some of the best elements of fixed income (yields and less volatility) with the best part of stocks (capital appreciation). It may be a great fit for older clients that need to keep a significant allocation to equities. It is also quite affordable at 0.27%.
Is the US headed for a major slowdown? That is the big question, especially as the economic clouds darken around the globe. The rest of the world, from Europe to China, is slowing, but the US continues to hum along nicely. So are we the last ship that is going to sink, or will the US manage to defy the tides and keep growing strongly? Looking to markets, yields around the world have fallen (including a dramatic increase in negative yielding European bonds), showing that investors are growing more bearish about the economic outlook.
FINSUM: With the Fed paused, we do not see an imminent recession by any means. We do, however, feel the US economy and markets lack a strong narrative at the moment, which makes us slightly nervous.