Markets
(New York)
Investors likely already know that low cost index funds tend to greatly outperform high fee actively managed funds (to the tune of 1.5% or more annually). That comes as no surprise. However, what was surprising to us is that in fixed income, the tables are greatly turned. While passive funds do have a slight edge over active ones on average (0.18% per year), in many cases high fee actively managed fixed income funds outperform passive ones. This holds true over long time periods, including ten-year horizons.
FINSUM: This is an interesting finding and one that makes intuitive sense. The bond market is vast, hard to access, and full of intricacies. That kind of environment lends itself to specialism in a way that large cap equities does not, and the performance metrics show it.
(New York)
The yield curve inversion has largely faded from headlines. Things that become the status quo often do! But in that development lays a hidden but worrying truth—the longer the yield curve is inverted, the more likely it is that there will be a recession. The inversion has been in place for over a month now and it is actually getting worse, with long-term yields continuing to drop. A yield curve inversion has proceeded every US recession in the last 50 years.
FINSUM: If the Fed proceeds with cuts, it seems like the inversion may abate. But then again, the rate cut would be an implicit admission that we are on the way to a recession.
(Chicago)
There is no arguing it, small caps have had a rough year. While the S&P 500 is up 9.4% from a year ago, the SmallCap 600 is down 8.4%. The divergence has been surprising to many, as several macro trends appear favorable for small cap appreciation, such as the trade war. However, for small caps to really get wind in their sails, things needing to be looking up in the economy, which seems unlikely in the short term. Therefore, one of the best ways to bet on size in your portfolio is to buy a specialized fund like the iShares Edge MSCI USA Size Factor ETF, which holds stocks in inverse proportion to their size. The smaller the stock, the greater its weight in the fund, helping investors skew towards small stocks, but not totally away from larger ones. The fund has outperformed the S&P 500 this year.
FINSUM: This is a very specialized angle, but does make some sense. We agree with the assessment of small caps right now—the underlying economy is not favorable for small cap bullishness.
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(Washington)
It is no secret that Trump is a critic of the current Federal Reserve. He has frequently complained about Powell and wishes the Fed would take a more dovish stance. Well, he took a step towards making that dovish position a reality this week as he has just appointed two notable doves to the Fed. One is Judy Shelton, an economic adviser to his 2016 campaign, who will now be on the Fed’s board. The other is Christopher Waller, who will be the head of research at the St. Louis Fed. Shelton has numerous times expressed extremely dovish views and has said she does not like the Fed’s way of setting rates and would instead prefer a market-set rate.
FINSUM: Shelton’s views are pretty revolutionary, so it seems like she could really shake things up.
(New York)
Gold has been doing well recently. Between global trade turmoil, a falling economy, and decreasing yields, the metal has thrived. Here are three reasons the gains won’t reverse. The first is that the stock market continues to look risky, meaning gold’s allure as a safe haven seems assured. Secondly, yields on bonds have a definitively downward direction, which makes gold more attractive. Finally, inflation is unlikely to stay low forever. When it starts to rise, it would give investors another reason to bet on gold instead of bonds.
FINSUM: We don’t really think inflation will be much of a factor for gold in the immediate term, but the first two points are material.
(New York)
Yes, the market is at or near all-time highs. Yes, the Fed is dovish, which is mildly bullish for markets (or very bullish if the economy stays in decent shape). However, equities are sending some strong warning signals too. In particular, two sectors which often act as bellwethers are showing that the market may be headed for a decline. Both small caps and transportation stocks have been struggling, a development usually associated with a market headed south. The sectors have declined at a rapid pace, and relative to the S&P 500 as a whole, are at their weakest point since 2009.
FINSUM: This is a signal similar in nature to the yield curve inversion. Is it material or just an aberration? Anyone’s guess.