We expect moderate economic growth to continue, with no recession imminent. We recommend owning a variety of equities and bonds of varying maturities, including high-yield bonds, to reduce risk associated with the return of normal volatility in the late stages of the economic cycle.
Yield curve still signaling growth – We expect the gap between short- and long-term rates, known as the yield curve, to stay flat, signaling moderate economic growth ahead. Earlier this year, a part of the yield curve – namely, the gap between the 10-year note and three-month bill – briefly inverted. Historically, this inversion is an early indicator of recession, but this is not always the case. With economic fundamentals positive and growing modestly, we don’t think a recession is imminent.
Interest rates are low and on hold – We expect the Federal Reserve to keep short-term interest rates at current levels of 2.25% to 2.5% if inflation stays near the Fed’s 2% target and the U.S. unemployment rate remains near 50-year lows. If so, the Fed will have latitude to be patient and data-driven before acting on rates again. We don’t expect the Fed to cut rates this year unless economic or job growth weakens considerably. The Fed could also raise rates if the economy improves and inflation increases at a stronger pace.
A variety of stocks and bonds helps smooth performance – In the late stages of the cycle, we expect a return to normal levels of volatility. Bonds can help reduce swings in equities because their prices often move in opposite directions. When stocks are falling, bond prices usually either rise or fall less. Conversely, when stocks are rising, the performance of portfolios with bonds tends to lag. Over the long term, portfolios with a mix of equities and bonds, including investment-grade and high-yield securities, are more likely to produce positive returns than equities alone.*
While you can’t predict the future direction of rates, you can prepare your portfolio by owning the right mix of stocks and bonds of varying maturities that aligns with your comfort with volatility. Additionally, including high-yield bonds as appropriate has historically provided investors with higher returns and steadier income than just equities and investment-grade bonds alone.
*Source: Morningstar Direct, 1/1/1976–12/31/2018. Past performance is not a guarantee of what will happen in the future.
Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal.
Before investing in bonds, you should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease, and the investor can lose principal value if the investment is sold prior to maturity.
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