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Are You Borrowing Trouble Instead of Being Prepared?

By Kate Warne October 01, 2019

When the headlines suggest calamity, it may seem natural to think things can only get worse. But as your mother probably told you, “Don’t borrow trouble.” Anticipating problems that haven’t happened can keep you from reaching your goals and may make you hesitant to invest. We think many of today’s challenges could continue to trigger short-term volatility, but our outlook remains reasonably positive.

Slower economic growth, the manufacturing slump and escalating global worries, including trade tensions, are legitimate concerns and challenges for investors in the later part of the economic and market cycle, but they don’t indicate a recession or bear market is near. In fact, we believe today’s low interest rates and expectations of additional Federal Reserve rate cuts are likely to extend this long-running expansion and bull market. Historically, staying invested through uncertain conditions has been a successful strategy.* Don’t borrow trouble by selling investments to avoid a pullback or recession that may not happen soon.

Is the bond market signaling trouble ahead?

We don't think so. An inverted yield curve (when short-term interest rates are above long-term rates) has preceded recessions in the past. But this signal isn’t timely or infallible: The past six recessions started between seven and 23 months later, and two inversions (1966 and 1998) weren’t followed by a recession. Even if a recession is ahead, it may not start soon. Negative rates in the rest of the world may be distorting the signal, and none of the other recession indicators we watch has signaled a recession yet.

In addition, the yield curve doesn’t predict short-term stock market moves. After a yield curve inversion, stocks were higher about half the time over the following year, with an average return of 1%. But low rates make a recession less likely, and if a recession didn’t start within 10 months, stocks were up 13%. That’s why we think you should stay invested and not react to the yield curve alone.

Our recommendation: If you’re tempted to react, we think that’s the wrong move. Stay patient and invested, as most signs suggest the late cycle extends longer.

Source: Morningstar, FactSet, Stock market returns based on S&P 500 total returns; yield curve inversion based on 10-year and three-month Treasury yields. Recession lag measured in months; monthly data may not equal yearly totals.

Low but positive interest rates

Negative interest rates in the rest of the world have perplexed investors, but they’re not likely here. Negative rates are the result of central bank policies in Europe and Japan, combined with much slower economic growth and lower inflation than in the U.S.

Pushing rates below zero hasn’t boosted growth or inflation as hoped, making them less likely here. The Fed has room to cut rates and, if necessary, could resume buying bonds or take other policies to keep the expansion going. As a result, we think U.S. rates are likely to remain low but don’t fall below zero.

Our recommendation: Keep enough in cash and bonds to help reduce fluctuations in the value of your investment portfolio, making it easier to stay invested during today’s high uncertainty about economic, trade and interest rate policies.

Slower growth, not recession

Although a few recession signals have flashed red or yellow, we think the outlook is slower growth, not recession. Consumer spending makes up almost 70% of economic growth, and consumers remain healthy, supported by solid job gains.

The unemployment rate is near a 50-year low, with many employers searching for workers, and wages were up 3.2% over the past year, giving consumers the ability to spend. Despite the slump in manufacturing and declining exports, the Leading Economic Index (LEI) is consistent with modest economic growth of 2% to 2.5%.

Slower but positive economic growth and a return to slow earnings growth, combined with attractive valuations, give us a positive outlook for stocks. However, the path is likely to be bumpy due to the challenges and headlines.

Our recommendation: Don’t borrow trouble – stay invested despite the uncertainty, and prepare your investment portfolio for continuing volatility by rebalancing to the right mix of stocks and bonds based on your comfort with risk, time horizon and goals. Don’t try to time the market by making bigger investment moves or keeping too much in cash to avoid a downturn that may not happen.

Important Information:

*Source: Morningstar Direct. Past performance is not a guarantee of future results.

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