Summer Quarterly Commentary

“What, Me Worry?”
Alfred E. Neuman (1956-2019)
Fictitious mascot and cover boy of the American humor magazine Mad

In early 2007, delinquencies in subprime mortgages began to spike but few took notice. The first real headlines were made in June 2007 when two Bear Stearns hedge funds specializing in the area went down, but few were worried about Bear itself. By September 2007 the problems were widespread enough for the Fed to act aggressively and cut interest rates a full half point instead of the typical quarter point move, in an effort to make sure they weren't "behind the curve". Thankfully, due to these bold efforts, by early October 2007, well after the start of the troubles, the stock market was hitting all-time highs, and they all lived happily ever after. Just kidding.

This is what today feels like. Not because we think we are about to have a financial crisis, but because there are (probably less serious1) economic clouds on the horizon, and the Fed has recognized them, and therefore all but promised to cut rates, and as a result stocks have zoomed to new all-time highs. The S&P 500 just passed 3,000 for the first time; the Dow just passed 27,000 for the first time. Back in 2007, we were scratching our heads and wondering why stocks were focusing only on the rate cuts and ignoring the reasons for the rate cuts; we are scratching our heads today.

We are worried. To be fair, we are also probably wrong, because things are usually fine and the stock market usually goes up, but we are worried. It is not just us. There are several important entities that agree with us.

The most important entity that agrees with us is the bond market. Usually bonds and stocks move in opposite directions. When things are good, stocks are up and bonds are down, and when things are troubling, stocks are down and bonds are up. Recently, they’ve both been moving up. So stocks say things are fine, whereas bonds say things are not fine. When equities and credit disagree, generally it is thought better to listen to bonds as the “smarter” market, especially when it comes to the macro economy2. Stocks can get buoyed by manic sentiment and thoughts of unlimited upside. Bonds have extremely limited upside and mainly worry about the downside.