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Index Month / Year to Date

Dow Jones +1.44%/+8.98%
S&P 500 +0.46%/+9.13%
NASDAQ -0.80%/+14.80%
10-Yr Treasury yield was at 2.20% at the end of May and 2.30% at the end of June

Source: Bloomberg.com

Markets:

For the most part, the stock market rally rolled on in July, shrugging off new controversies and setbacks in the Trump administration and the ongoing lack of any real substantive economic progress. Words like “modest” and “moderate” continued to dominate expert assessments of the economy—the same terms Fed Chairman Janet Yellen used in June to justify raising short-term interest rates for the second time this year.1

If those adjectives don’t seem sufficient enough to explain a stock market that has risen 15 percent since Trump’s election, it’s because they aren’t. They don’t justify the Fed’s move, which we believe is a major gamble considering that it threatens to flatten the yield curve. The yield curve is based on the differential between long-term interest rates and short-term interest rates. Banks need long-term rates to rise ahead of short-term rates in order to make lending worth their while.

Long-term interest rates have not moved in accordance with the Fed’s expressed economic confidence or with the apparent optimism shown by Wall Street since Trump’s election. The 10-Year Treasury rate did rise from 1.8 to 2.6 in the month following the election, but it hasn’t gone higher since.2 In fact, the 10-Year was at 2.25 in December of 2015, and while short-term rates have gone up a whole point since then, long-term rates have barely budged.2

Apparently, the Fed is pushing ahead with its vow to raise rates despite the risk of flattening the yield curve. In other words, the Fed is basically betting on the idea that long-term rates are going to start rising, in much the same way that big investors are betting that Trump is going to make good on his lofty promises of economic growth.

As for how long they will be willing to stick with that bet remains to be seen. If fall arrives and Trump’s economic proposals should end up like his healthcare bill—which hit another brick wall in July—will the markets be able to shrug that off as well? Investors over 50 with significant stock market exposure should be particularly prudent, especially considering that the market is overvalued and that the third major correction of our current long-term secular bear market cycle has yet to occur.

1 Lauren Gensler, “Fed Raises Interest Rates for Second Time in 2017,” Forbes, last modified June 14, 2017

2 Ycharts.com