|10-Yr Treasury yield was 1.5060% at the end of August and 1.6750% at the end of September|
As September gave way to October, the stock market took another big dip, with the Dow Jones Industrial Average falling around 900 points in two days. This latest swoon was attributed mainly to news that the US manufacturing index posted its weakest reading since 2009.* While President Trump blamed the Federal Reserve, many economists blamed the Trump-China trade war—even as most of the headlines continued to focus on Congress’s new impeachment inquiry into the president.
So far, Wall Street seems to be shrugging off the impeachment issue, and the stock market remains basically locked in the same nervous holding pattern it’s been in since the start of 2018. However, there’s a possibility that could change—particularly when you factor in all the other uncertainties affecting the markets these days, which include recession fears, new tensions in the Middle East, and a partially flat yield curve.
What didn’t grab many headlines in September was an incident that I think may be another potential warning sign for both the economy and financial markets. On September 16th, the US banking system experienced an overnight liquidity crunch in which, suddenly, banks didn’t have enough cash on hand for repurchase agreements, a.k.a. repos. As a result, the Fed Funds Rate momentarily spiked to 10%. This occurred just days before the Fed was set to lower the rate from 2.25 to 2%. With no other choice, the Fed had to step in and immediately pump cash into the banking system, pledging to allow roughly two weeks of overnight repo transactions, each injecting around $75 billion daily into the economy.**
There are a variety of theories about how this happened, but no one has offered a definitive explanation. As an advisor, I get nervous in this kind of situation because it feels all-too familiar.
As one writer put it bluntly: “The repo market is looking a lot like it did on the precipice of the 2007 housing market crash.”** Whether that assessment is accurate or not, the incident should certainly give investors pause—especially those still not sure if they’ve adequately reduced their own stock market risk.
As for the bond market, the yield on the 10-Year Treasury rate seems to have stabilized at around 1.4%, and our account managers remain committed to getting good competitive yields on behalf of our clients without taking excessive risks.
When managing your portfolio at SIS, we look for one of four possible “enhancement” trades while reviewing securities and possible transactions. Income generation is our primary goal for our clients, and we consider the following four portfolio enhancements before transacting: current yield, yield to worst (minimum projected annualized total return), interest rate risk, and default risk. The intents of these transactions are categorized as follows:
- Pay Me Now – Enhancing current yield
- Pay Me Later – Enhancing yield to worst
- Cover My Assets I. – Managing interest rate risk
- Cover My Assets II. – Managing default risk
We evaluate the transactions by determining whether they meet one, two, three, or all four enhancements. A baseball analogy for this: SINGLES, DOUBLES, TRIPLES, and HOME RUNS.
*“US Factory Gauge Hits 10-Year Low as World Slowdown Widens,” Yahoo Finance, Oct. 1, 2019
**“Why the Repo Market is Such a Big Deal—and Why its $400 Billion Bailout is So Unnerving,” fortune.com, Sept. 23, 2019
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