Investors Remain Confident Despite Declining Economic Growth

Many stock markets around the world moved higher last week.

Investors’ optimism in the face of economic headwinds has confounded some in the financial services industry. Laurence Fletcher and Jennifer Ablan of Financial Times cited several money managers who believe investors have become complacent. One theory is investors’ buy-the-dip mentality has become so firmly ingrained that any price drop is seen as a buying opportunity, regardless of share price valuation.

Another theory is investors remain confident in the face of declining economic growth expectations because they expect central bankers to save the day:

“Key stock markets are hovering close to record highs even while the death count from the China-centered virus rises and travel in, out, and around the country remains heavily restricted, hurting the outlook for domestic and international companies. Regardless, stumbles in stocks are quickly reversed. To some traders, this is proof that investors believe major central banks will pump more stimulus into the financial system.”

Ben Levisohn of Barron’s doesn’t think investors in U.S. stocks are complacent. He wrote:

“Yes, [investors have] decided to stay invested in U.S. stocks, but compare it with the other options. Emerging market stocks near the epicenter of the outbreak? Treasury notes with yields of just 1.59 percent? Cash? But, they haven’t sat idly by, either. They’ve dumped the stocks most exposed to coronavirus and to a slowing economy – things like energy, cruise lines, airlines, steel.”

Treasury bond markets are telling a less optimistic story than stock markets. The U.S. treasury bond yield curve has flattened in recent weeks. On Friday, 3-month treasuries were yielding 1.58 percent while 10-year treasuries yielded 1.59 percent. When there is little difference between yields for short- and long-term maturities, the yield curve is considered to be flat.

Historically, the slope of the yield curve – a line that shows yields for Treasuries of different maturities – is believed to provide insight to what may be ahead for economic growth. Normal yield curves may indicate expansion ahead, while inverted yield curves suggest recession may be looming. Flat yield curves suggest a transition is underway.

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