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Mr. Ten Year – Please Stand Up

CAMS Weekly View from the Corner – Week ending 10/5/2018

October 8, 2018

On this note it is important to realize markets look out into the future and trade according to “what they see” (or think they see) hence we experience unexpected, if not confusing volatility at times. CAMS Weekly View – 10/1/18 – A New Low in This Economic Indicator

Culturally it is tradition that we have those stand up when we are offering distinction to them for any particular reason.  In today’s View we are calling specific attention to the 10 Year Treasury bond.  This is a crucial benchmark interest rate that impacts the economy broadly which is to say it impacts nearly all of us in some way.

Collective bond market participants have pushed this interest rate up notably in recent weeks and in particular, the last few days.  They do this by selling bonds which places downward pressure on bond prices and in so doing upward pressure on interest rates.

With this, market participants establish the interest rate on this benchmark bond by what they are “seeing” out there in the general economic landscape.  They have determined this interest rate needs to go much higher in light of them concluding the economy is not only strong currently but they indeed expect it to remain strong for the foreseeable future.

Drilled deeper, inside this economic strength outlook is a tremendous concern the very tight labor market will spill over into a near bidding war for labor and hence spike wage growth rates upward from here rather than gradually moving higher.  This invokes the old adage that too much of a good thing can indeed be a negative.

The aforementioned “seeing” part is where life starts to get interesting for all of us in differing ways depending on your exposure to various markets and how you may run your general household and/or business finances.

This is the case because the 10 Year Treasury Bond rate is a benchmark interest rate that plays into many markets and impacts other interest rates such as auto loans, credit cards, student loans and mortgage rates to name a few.


As an example, the above chart depicts the rolling relationship of mortgage rates and the 10 Year Treasury Bond rate.  The thick black line represents the 10 Year Treasury while the red line depicts the 15 Year Fixed Mortgage rate.  As we can see both are moving higher and all began to rise in late 2016.  (As goes the black line so goes the red line to keep it simple.)

Increased interest rates across the economy brings an increased cost of doing business or acting in your personal economy – think auto loans, credit card purchases and higher mortgage rates.  Increasing costs invites (doesn’t guarantee) reduced economic activity.  Reduced economic activity places a more challenging backdrop for companies collectively to increase their sales and profits.

In the case of the stock market even a hint of a more challenging economic environment downstream brings with it uncertainty and increased volatility as investors work to ascertain how “at risk” forward economic growth may be in light of notably increasing interest rates.

If economic growth dissipates or turns negative, Real Estate markets on through to the stock market will be vulnerable to notable downside price action in light of how historically highly valued they are.

Speaking of highly valued markets the Real Estate market has become particularly strange.

The S&P Index of Home Construction stocks are down 28% thus far in 2018!  This is an astounding number for a housing market that is strong – or is it?  The most recent release of Existing Home sales were negative compared to year ago sales levels.  In addition, every month from spring through summer the existing homes market has posted lower unit sales results.  Strange?

With the Home Construction Index deeply in the red market participants are clearly stating concerns for the forward strength of the housing market overall.  Importantly, the housing market is a significant pillar in the economy as a whole and if it weakens to the point of a downtrend overall economic strength will ultimately be dinged at best and notably hurt at worst.

Rising interest rates in the bond market are inviting increased scrutiny to markets overall and with this, volatility is on the rise.  Keep in mind, markets are not one-way streets.  They can go up and they can go down too.  Know what you can handle volatility-wise and invest to your comfort level.

I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis

Portfolio Manager, CAMS Spectrum Portfolio

Footnote:

H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP).  This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”.  A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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