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|10-Yr Treasury yield was 1.91% at the start of 2020 and 1.50% at the end of January.|
Despite two brief dips in January, the stock market managed to recover and hit multiple new record highs. The Dow Jones Industrial Average topped 29,000 for the first time ever on January 15th, and by February 5th it was back above 29,000 and approaching its peak high.* This occurred despite ongoing geopolitical instability around the world, and despite a report from the Commerce Department that the U.S. economy had missed President Trump’s 3% growth target for the second straight year in 2019.**
Meanwhile, after having stabilized at between 1.75 and 2% for several months, the yield on the 10-Year Treasury rate fell further in January, hitting 1.51% on the last day of the month.*** With the current Fed funds rate at a range of 1.5 to 1.75%, this puts the yield curve close to inverting again, as it did briefly in 2019, creating a classic recession warning sign. What all this means is that the disagreement between the stock market and the bond market over the strength of the economy deepened in January. The more logical bond market still opposes the idea that the economy is strong enough to justify soaring stock prices, which reinforces the likelihood that what we’re seeing is a blow-off top: a period of fairly steady stock market growth that occurs amid mixed economic data, and is often followed by a steep correction.
As I noted in my 2020 market forecast, this blow-off top could continue building up froth throughout the year before that correction hits—largely because the Fed has sent a clear signal that it will continue doing everything in its power to keep it going. President Trump is also likely to do everything he can to keep Wall Street happy ahead of the November elections, including announcing an expected second round of tax cuts sometime this spring or summer.
Ultimately, though, I believe investors should pay attention to the bond market’s message and be aware that there are now numerous unstable situations that could trigger the next sustained market correction at any time. In my experience, most rational investors already recognize that the froth on this blow-off top is artificial, and they don’t want to bet on something that isn’t real. If, however, you have friends who are still caught up in the hype, you might want to let them know that now is an ideal time to reduce their own market risk by switching their strategic focus from growth to income.
When managing your portfolio at SIS, we look for one of four possible “enhancement” trades while reviewing securities and possible transactions. Income generation is our primary goal for our clients, and we consider the following four portfolio enhancements before transacting: current yield, yield to worst (minimum projected annualized total return), interest rate risk, and default risk. The intents of these transactions are categorized as follows:
- Pay Me Now – Enhancing current yield
- Pay Me Later – Enhancing yield to worst
- Cover My Assets I. – Managing interest rate risk
- Cover My Assets II. – Managing default risk
We evaluate the transactions by determining whether they meet one, two, three, or all four enhancements. A baseball analogy for this: SINGLES, DOUBLES, TRIPLES, and HOME RUNS.
There were no swaps for the month of January.
*Dow Jones 10-Year Daily Chart, Macrotrends.com
**“U.S. Economy Misses Trump’s 3% Growth Target in 2019,” Reuters, Jan. 30, 2020 ***10-Year Treasury Rate, Y-Charts
Note: The above trades were recent block trades and do not reflect all trades done on an individual specific basis. Sound Income Strategies, LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Past performance is not an indication of future results. Be sure to first consult with a qualified financial advisor or tax professional about your specific financial situation before implementing any strategy discussed herein.
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