“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.” – Peter Lynch

Summary

Well known ex-mutual fund manager Peter Lynch took a hard stance against investors over-prepping for corrections. So, his words could not be more apropos for today’s market environment.

Given the current bull market the market near all-time highs, there is a continual undercurrent of opinion that we could be facing a correction and/or recession sometime in the future.

At the same time, statistics show long-term investors are better off staying in the market during corrections and bear markets than attempting to time the market.

Meanwhile, Wall Street sold off sharply on Wednesday as recession fears gripped the market after the Treasury yield curve temporarily inverted for the first time in 12 years. 

The major equity indexes closed about 3% lower with the blue-chip Dow Jones Industrial Average posting its largest one-day point drop since October after 2-year Treasury yields surpassed those of 10-year bonds, which is considered a classic recession signal.

Dire economic data from China and Germany suggested a faltering global economy, stricken by the increasingly belligerent U.S.-China trade war, Brexit woes and geopolitical tensions.

Germany reported a contraction in second-quarter gross domestic product, and China’s industrial growth in July hit a 17-year low.

Wednesday was the first time that yields for 2-year and 10-year Treasuries had inverted since June 2007, months before the onset of the great recession, which crippled markets for years. The U.S. yield curve has inverted before every recession in the past 50 years.

The CBOE volatility index, a gauge of investor anxiety, jumped 4.58 points to 22.10.

Over 300 of the S&P 500’s components are down 10% or more from their 52-week highs, according to Refinitiv data. More than 180 of those stocks have fallen more than 20% from their 52-week highs, putting them in bear market territory.

The 11 major sectors in the S&P 500 all closed in negative territory, with energy, financials, materials, consumer discretionary and communications services all falling 3% or more. Interest rate-sensitive banks tumbled 4.3%.

Macy’s fell 13.2% after the department store operator missed quarterly earnings estimates and cut its full-year earnings estimates.

Rival department store operators Nordstrom Inc and Kohls Corp fell 10.6% and 11.0%, respectively.

A House of Representatives oversight panel called on Mylan and Teva to turn over documents as part of a review into generic drug price increases. Mylan fell 8.5% while U.S.-listed Teva shares dipped 10.5%.

Facebook was down 4.6% on news that the European Union’s lead regulator is investigating how the social media company handled data during the manual transcription of users’ audio recordings.

The second-quarter earnings season approaches the finish line, with 454 of the companies in the S&P 500 having posted results. Of those, 73.1% beat Street estimates, according to Refinitiv data.

Analysts see S&P 500 second-quarter earnings growth of 2.8% year-on-year, per Refinitiv.

Approximately 8.68 billion shares changed hands on the major domestic equity exchanges, as compared to the 7.47 billion share average over the last 20 trading days.

Yield Curve Inversion Breeds Fear

When the Fed cut interest rates last month, it signaled that further reductions in borrowing costs might not be needed. Bond markets vehemently disagree.

Sliding bond yields and the inversion of a key part of the U.S. yield curve on Wednesday for the first time in 12 years show that bond investors have a far gloomier outlook for the U.S. and global economies than the U.S. central bank.

Fears are also rising the Fed may not only be behind the curve in cutting rates, but that central banks may be running out of ammunition to stimulate growth as countries offset each other’s attempts to boost growth with looser fiscal policy.

Worsening economic data, weak inflationary pressures, the escalating U.S.-China trade war and intensifying tensions between protesters in Hong Kong and the Chinese government have increased demand for safe-haven debt, sending the longest-dated Treasury yields to record lows.

The inversion of key parts of the Treasury yield curve, in which investors in short-term holdings get paid more than those in long-term ones, has some correlation with the possibility of a coming recession.

On Wednesday, the yield on the 10-year Treasury note moved 2.1 basis points below 2-year Treasury yields, the first time this spread has been negative since 2007, according to Refinitiv data.

The inversion rattled investors already worried that a U.S.-China trade war might trigger a global recession and kill off a decade-long bull market on Wall Street. Major U.S. stock indexes were down nearly 3%.

At the start of the year, markets and central banks were more optimistic on the global economic outlook. The Fed projected to continue hiking rates after raising borrowing costs four times in 2018.

That shifted in March when the Fed brought an end to its hiking cycle. In conjunction with disappointing manufacturing data, the move sparked broad repositioning that led the 3-month/10-year yield curve to invert for the first time since 2007. That was followed in July by the Fed’s first rate cut since 2008.

The Fed looks better placed to ease conditions than many of its counterparts as it still has room to cut rates. Bond markets are priced for two additional U.S. rate cuts this year and a third in the first half of next year.

By easing financial conditions, a central bank can stimulate an economy by making business and consumer loans cheaper, while the depreciation of the local currency that results from lower interest rates can boost exports.

As central banks compete for more dovish policies, however, they threaten to cancel each other out, making each move less effective. To that end, a chorus of central banks including those in India, Thailand and the Philippines cut rates during the week.