The inverted yield curve, a key predictor for financial downturns, has appeared in recent months several times. Yet U.S. stock markets are still near their all-time high while U.S. retail sales appear upbeat. Paying attention to the yield curve inversion that has predicted each of the last seven downturns, could be mistaken this time around, or are we simply deluding ourselves?
History suggests that the correlation between an inverted yield curve and the subsequent downturn stands by its predictive power. Indeed, the spread between the 10-year and the 3-month has sustained its inversion almost perfectly for exactly a quarter and that has been a clear sign of a recession every time. The problem is that Wall Street pays attention to indicators such as GDP, unemployment rates, and consumer confidence, which are all lagging indicators—they give a snapshot of what has happened over the past quarter.
Of course, the curve inversion reflects high uncertainty and high expectations of a recession, rather than directly determining a recession. And, the inverted yield curve doesn’t exactly predict when a recession is coming. In the past, it has typically taken between 12 months to 18 months for a recession to materialize itself.
So, what are investors to do in these times of high uncertainty and all time highs?
Future Wealth View
Not paying attention to economic signals is simply foolish. Hoping that the bull market that has the best run since “ever” and that it will continue for another few years or another decade is also foolish. Libraries groan from the weight of books that fill the shelves with stories of fund managers who have taken strong bets going short or long at the wrong time. Of course, none of these books talk about investors who lost 20, 40 or 80 percent of their savings from ill-advised moves by the same fund managers.
Here is the situation – Hong Kong is a hair’s breadth away from destruction and China is feeling the heat, Europe and its Brexit strategy is a story that can’t be told coherently by anyone and the US is as secure as Trump’s temperament will let it be and there are no wisemen left in the room. Markets are whipsawing everyday to news that has simply no relevance. With this backdrop, does anyone dare to challenge economic signals and stay “all-in”?
At Future Wealth LLC, our motto has been capital preservation before anything else. The vast incoherence of the bullish signs in the market is in itself a cautionary sign, in our view. Not paying attention to economic signals that are shining “code red” could make 2008 financial crisis seem like another day in the park. You don’t want to be anywhere near that park.