Every investor seems to assume that this bull market is nearing its expiration date. Good things must come to an end, after all. However, Barron’s is arguing (rather adamantly) that this bull market could perhaps go on for another ten years. Reminding us of the old adage that bear markets don’t die of old age, Barron’s says there is just no sign of real weakness. “As far as the U.S. economy is concerned, there is no obvious sign that it has deteriorated”, says the publication. What about the yield curve? They say that is just an adjustment to tighter monetary conditions and not predictive of a recession in this case.
FINSUM: There is undoubtedly an element of superstition/intuition which is making investors feel like this bull run must come to an end soon. But the reality is that the underlying conditions for that to happen may not be in place.
What is the biggest short-term risk to markets? Is it a recession, China trade relations, and EU meltdown? None of the above. Rather, it is the upside risk of better economic data. A short burst of good US economic data, and the resulting comments from the Fed, could send US bond markets into a tailspin after the huge rallies of the last several weeks. The market for long-term Treasuries looks overbought, which means a reversal in economic data could bring a lot of volatility which could even whiplash equities.
FINSUM: At this point, a round of good economic data, and a stray hawkish comment from the Fed, would deeply wound bonds and hurt equities too (because everyone would again grow fearful of hikes).
The yield curve is the center of attention right now. The short end is yielding more than the long end, everything feels upside down. So how to play it? Yields on long-term bonds have fallen so steeply that it seems foolish to think they will continue to do so. Inflation is still around and the Fed still has a goal to get the country to 2%, which means yields seems more likely to rise than fall (unless you think a recession is imminent). Accordingly, there are two ways to play this curve. The first is to use a “bullet” strategy by buying only intermediate term bonds, which tend to do well when the yield curve steepens, especially if short-term rates actually fall. For this approach, check out the iPath U.S. Treasury Steepener ETN (STPP). The other option is to remain agnostic as to direction, buying something like the iShares Core U.S. Aggregate Bond fund (AGG).
FINSUM: Our own view is that we are not headed into an immediate recession, and thus the long end of the curve looks overbought.
Yield curves are widely known to be the best indicator of forthcoming recessions, hence why the market is spooked. However, a lesser known fact is that they are also good indicators of presidential elections. Looking historically, whenever the yield curve is inverted at the time on an election, the incumbent loses. This occurred in 1980 in Reagan’s victory, as well as in the 2008 election of Obama. Both times, the yield curves were inverted and the economy in recession. That said, flat yield curves don’t seem to have much effect at all and hold little advantage for either party.
FINSUM: Given that recessions usually take 12 to 18 months to start once the curve inverts, it is entirely possible that one could begin just before the 2020 election.
The professor who first identified yield curve inversions has written an article explaining what the development really means. First identified in 1986, a yield curve inversion is considered the most widely accurate indicator of recession. Since it was first identified and back tested, it has accurately predicted a further 3 out of 3 recessions. This is a point its “discoverer” Campbell Harvey hammers home in his article. He explains that an inversion is usually followed by a recession within 12-18 months. The yield curve has not been inverted since before the Crisis, but just did so on Friday.
FINSUM: One of the important points Harvey makes is that in order for the inversion to really indicate a recession, it needs to remain in place for at least three months. We are only at one day.