Although historically August can be a difficult month for equities, that was not the case this year. The S&P 500 tacked on another gain in August, rising by 2.1%, similar to the 2.3% gain registered in July. Even better, the small-cap Russell 2000 Index enjoyed a robust 7.2% increase last month. Also joining the party were bonds, with the Barclays US Aggregate Bond Index advancing by 1.2% in August and posting an impressive 5% YTD return.
Despite the fact that economic news continues to worsen in key areas (employment, consumer sentiment, leading economic indicators (LEI)), equity investors remain steadfastly bullish in their outlook. Nearly every pullback in the market prompts eventual buying, providing a sturdy floor for prices. We’ve discussed in past investment letters the many reasons our expectations are tempered and cautious. And yet the clarion promise of an AI boom in the very near future has served as the catalyst catapulting stock prices to new highs.
As long as the perception that AI will massively transform global economies continues to be accepted as a most-probable outcome, then stock prices will likely remain buoyant. However, if this rosy belief suddenly becomes questionable, or even doubtful, equities could very well suffer, dearly. As a reminder, the internet bubble in 2000 was preceded by a similar belief that the internet was going to change everything, resulting in huge profits for most companies. While it can be argued the internet certainly did change everything, the problem was valuations were discounting future growth to be much larger, and delivered sooner, than what was realistically achievable. Investors gradually readjusted their expectations, leading to the bursting of the bubble. The ensuing recession in 2001 worked to further push stock prices lower and compress valuations. Such a scenario could occur again with respect to the current AI bubble. As Mark Twain once famously said, “History doesn’t repeat itself, but if often rhymes.”
In addition to “AI mania” driving equities higher, there’s also the emerging notion that tariffs may indeed have little impact on the economy. To date, any price inflation due to tariffs has been minimal in most areas, fostering a sense of complacency that perhaps the so-called economic experts were wrong in their doomsday predictions. Although it wouldn’t be the first time the “experts” were wrong, in their defense they would likely argue that it’s too soon to feel the impact of tariffs, which typically have a delayed effect. Many companies accelerated import activity pre-tariffs to stockpile inventory, and they’ve also been absorbing the increased costs to consumers due to tariffs. But the artificially high inventories are depleting fast and companies are not going to absorb tariff costs forever, adversely affecting their profits. We believe the inevitable will happen, tariffs will at some point cause inflation, which could reduce demand for goods, possibly leading to an economic recession.
Admittedly, all of the above may sound confusing, and in many ways it is, largely due to so many moving parts at play, and depending on which gain the upper hand, very different end results are possible. It’s why we diligently review our many indicators to hopefully glean clues and insights on what is the most probable outcome(s).
As an example, the 10-year Treasury yield can serve as a powerful leading indicator.
Before an economic recession arrives in earnest, longer-term interest rates (like the 10-year Treasury yield shown in the chart above, red line) tend to decline months ahead of time as fixed-income investors discount the oncoming economic weakness and therefore Fed rate cuts. The chart shows the 10-year Treasury yield recently breaking down below its 1-year trend line, reaching a 4.1% yield after peaking at 4.8% in January. This downward trend change in long-term Treasury yields could be reflecting future anticipated Fed rate cuts in response to worsening economic data.
With regards to the Fed cutting rates, I thought it would be worthwhile to quote what I wrote in a prior investment letter:
The interest rate environments that are most bullish for stocks are either already low interest rates (not declining) OR rising interest rates. The worst environment for stocks is when the Fed is cutting rates, usually drastically.
The rationale for this makes sense since a Fed rapidly cutting rates usually means the economy is in bad shape, requiring immediate stimulus in the form of interest rate cuts. Equities then tend to sell off as investors are much more concerned about the weak economic conditions, all but ignoring the beneficial stimulative effects associated with the rate cuts.
Finally, I would be remiss if I didn’t include a reminder that September was by far the worst calendar month for stocks, as depicted in the following exhibit:
Apologies for sounding like a broken record (CD?), but we remain defensively positioned in client portfolios as we continue to believe the current environment warrants an emphasis on capital preservation over seeking more speculative sources of returns.
If you have any questions, please feel free to call or email.
The entire team at Measured Wealth wishes to thank you for entrusting us to deliver on your financial goals.
Edward Miller, CFA, CMT
Chief Investment Officer
Measured Wealth Private Client Group
Important Disclosures
Historical data is not a guarantee that any of the events described will occur or that any strategy will be successful. Past performance is not indicative of future results.
Returns citied above are from various sources including Factset, Bloomberg, Russell Associates, S&P Dow Jones, MSCI Inc., The St. Louis Federal Reserve and Y-Charts, Inc. The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. Investing involves risks, including possible loss of principal. Please consider the investment objectives, risks, charges, and expenses of any security carefully before investing.
In order to provide effective management of your account, it is important that we have current information regarding your financial status and circumstances. Please contact us in writing at 303 Islington Street, Portsmouth, NH 03801 if you have any changes in your financial situation or investment objectives, and whether you wish to impose any reasonable restrictions on the management of the account or reasonably modify existing restrictions.
Measured Wealth Private Client Group, LLC is an investment adviser located in Portsmouth, New Hampshire. Measured Wealth Private Client Group, LLC is registered with the Securities and Exchange Commission (SEC). Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. Measured Wealth Private Client Group, LLC only transacts business in states in which it is properly registered or is excluded or exempted from registration.
This publication is provided to clients and prospective clients of Measured Wealth Private Client Group, LLC for general informational and educational purposes only. It does not: (i) consider any person's individual needs, objectives, or circumstances; (ii) contain a recommendation, offer, or solicitation to buy or sell securities, or to enter into an agreement for investment advisory services; or (iii) constitute investment advice on which any person should or may rely. Past performance is no indication of future investment results. This publication is based on information obtained from third parties. While Measured Wealth Private Client Group, LLC seeks information from sources it believes to be reliable, Measured Wealth Private Client Group, LLC has not verified, and cannot guarantee the accuracy, timeliness, or completeness, of the third-party information used in preparing this publication. The third-party information and this publication are provided on an “as is” basis without warranty.
This publication may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “should,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio's operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of Measured Wealth Private Client Group, LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.