Q3 2019

After a difficult summer, equities moved higher in September to leave them flat for the quarter. In many ways Q3 saw a conflict between weakening economic data against further central bank easing and the prospect of accommodation in trade talks between the US and China.

The US 2/10 yield curve inverted in August (i.e. the annual yield on a US 10yr bond fell below that of a 2yr bond) for the first time since 2007 and such an inversion is often seen as a precursor of an economic recession. The five previous inversions of the US yield curve preceded recessions by 10-34 months, with an average lead time of 20 months. There are compelling arguments as to why yield curve inversion is not relevant this time. The most prevalent and appealing is that yields are so low world-wide, with an abundance of negatively yielding debt, this has pulled the yield on US treasuries below their fair value; in essence the inversion is technical rather than fundamental. However, it is also worth highlighting that at prior instances of inversion there have been what seemed at the time similarly compelling arguments.

The key question facing investors is when the next recession occurs and how deep this will be. The US yield curve inverted during the quarter and at least merits caution that it is indicating a recession, albeit the timing unclear. Fiscal and monetary policy is acting to mitigate this risk, but it is uncertain if this will be sufficient.  The consequences of zero or negative interest rates, or of an ever rising level of sovereign debt when the cost of servicing that debt is itself zero (or even negative), are unknown. We feel it wise to be cautious in positioning in this environment, taking targeted risk where we think real inefficiencies lie.