July 2019 Comments: Early August Volatility for Stock & Bond Prices

Sam Ngooi Comments

After relatively modest price changes during July in both stock and bond markets, early August witnessed a return of substantial stock and bond price volatility.

  • Although the recent declines (and gains) appear large in absolute numbers, the important figures are the percentage gains and declines. A drop of 500 points on the Dow, for example, sounds huge, but at current price levels it’s a more modest 2% decline. And depending on your specific allocation to stocks, these declines are moderated even further.
  • Markets currently seem to be responding to the daily news, focusing on the Fed’s position on US interest rates and the China trade dispute, involving both tariffs and more recently currency exchange rates. These factors have a direct bearing on the growth outlook for the US economy.
  • News that does not appear to be driving daily market price swings, for now at least, are the problems surrounding the Trump presidency and various international conflicts. These issues tend to have a more indirect bearing on the outlook for the US economy.
  • History has demonstrated that stock returns are determined by the underlying corporate earnings that support the price level of stocks (the Price/Earnings, P/E, ratio), an analysis that plays out over time and is impacted by many factors. To the extent the daily news items are likely to impact earnings, then there may be some connection of the news to market prices. But because the mix of factors and their significance are changing all the time, it is extremely difficult to make judgments on a day-to-day basis as to the appropriate level of stock prices. (As you know, we do not try to predict future stock price movements or their causation.
  • A few reference points for stock prices (S&P 500 index) may be useful:
    • At the time of Trump’s election in early November 2016, the index was 2,140.
    • At the end of 2018 (a year when the S&P 500 declined 6.2%), the index was 2,507, or a gain of 17.1% from Trump’s election.
    • At the end of July 2019, the index was 2,980, a gain of 39.2% from Trump’s election. With all the current day-to-day news that appears to be negative, stock prices have somehow continued to move considerably higher.
  • As for bond prices, they continue to move higher, as the benchmark ten-year US treasury yield has declined to around 1.7% in early August from its October 2018 high of 3.15%, a very substantial move. The Fed reduced the short-term rates it controls by 0.25% at the end of July 2019, but the ten-year yield has declined much more than short-term rates have (the inverted yield curve discussed last month), apparently anticipating a slower economy going forward and further rate reductions by the Fed. With a relatively modest 2.1% gain for Q2 2019, the most recent GDP report did show that “the American economy is slowing…but there are few signs that the decade-long expansion is on the brink of stalling out” (NYT, 7/26/2019, page A1).
  • When yields fall and bond prices rise, this is a mixed blessing for bond investors, since the yield is the income they receive from the bonds. At some point this cycle will reverse, with declining prices and rising income. The timing of this eventuality is very much an unknown.

What to do with this information? As our clients know, we advocate the long-term, stay-the-course approach, since timing markets is extremely difficult, if not impossible, and the allocations we recommend to clients have already taken into account the potential for declines in stock prices.