Inversion Update

Inversion Update

March 25, 2019 Off By Chuck

In June of last year, I wrote about how the US treasury yield curve was getting close to inverting and how that has historically been an accurate predictor of future recessions. Why it matters to investors is because a recession usually brings falling stock, commodity and asset prices (not all, but most risk assets), something we would prefer to avoid (as much as possible of). Obviously any prewarning we could get would be a bonus and allow to prepare for a high probability slide in risk asset prices. As history has shown, a yield curve inversion tends to precede recessions, unfortunately it doesn’t happen immediately nor consistently, varying from a period from 6 months to two years after the curve flips negative that the recession hits. At the same time yields invert, the stock market tends to continue its climb higher from the day of the inversion until it eventually hits its cycle peak. The timing of that stock market peak varies widely. All we know is stocks eventually peak and then fall. So, in summary, investors will get an early warning of a recession but won’t actually fall into a recession (if at all) until some point in the future which we, of course don’t know when it will occur. Add to that fact we won’t find out we are in a recession until after the fact and even if we do, the stock market won’t care …. until it does. Do I have that right? Ok, so much for the part about being prepared.

The reason I am resurrecting this topic is because, for a brief instance during last Friday’s session, the yield curve flipped negative. The good news, it closed 3 cents above the inversion level, the bad news, in my opinion, it is just delaying the inevitable. All facetiousness aside, investors would be wise to keep a close eye on the yield curve going forward. An actual inverted close and hold would be a time that investors should consider lightening up on risk asset exposure (that is unless the potential for a large drawdown is acceptable and you have time to make it back) and/or make sure you have an exit plan.

The good news is historically there has been ample time to make preparations if investors wanted to do so once the curve inverts. The bad news is, no one rings a bell and sometimes you take an early exit. I need to reiterate as of now we do NOT have an inverted yield curve so I may be nothing more than the boy crying wolf. But when you add this potential to the fact we are into the longest expansion without a recession ever in history, feel free to ignore the warning signs at your own risk.