Displaying items by tag: inversion

(New York)
There has been a lot of doom and gloom about the risks of an inverted yield curve lately. An inverted curve is often seen as the best and most reliable indicator of recession, as it has accurately preceded the last several US recessions. Some are saying this time may be different as market conditions and central bank created stimulus have warped markets. Well, despite the fact that many hate the “this time will be different” mantra, it may actually be true in this case. In particular, the inverted yield curve has only been reliable in the US, whereas in Japan and the UK it is not a good indicator. This means the indicator is by no means universal, and gives weight to the idea that an inversion does not necessarily mean a recession is coming.

FINSUM: The Japanese example is particularly interesting to us as the BOJ has long had extraordinarily accommodative monetary policy. In that sense it may be the best case study for how an inversion could play out this time.

(New York)

The yield curve is very close to inverting, an action that is widely considered to be the strongest and most reliable indicator of a forthcoming recession. Investors are afraid of it, and with good reason. So what is the best way to approach one’s portfolio as a dreaded inversion looms? The first tip is to re-evaluate any bank stocks you own. Banks become less profitable as the yield curve flattens, so they could see some big losses. Secondly, mentally prepare that returns over the next five years are probably going to be a lot lower than in the previous five. Be selective with your purchases and be defensive. Finally, don’t be too afraid to buy stocks you have a high conviction on, and that hold strong risk/reward profiles.

FINSUM: These seem like sound tips. Another obvious one is to buy stocks and bonds that will perform better in this kind of environment, such as strong dividend growing stocks or floating rate bonds.

(New York)

There has been a lot of focus, including both worry and skepticism, surrounding the potential inversion of the yield curve. The two and ten-year Treasury are now just 20 bp apart. Because yield curve inversions have been a very reliable indicator of recession, many are worried. However, some are skeptical that the current near-inversion means much because of how distorted long-term bond prices have become because of quantitative easing. The reality though, according to the FT, is that it doesn’t matter if long-term yields are artificially low. Because the market believes in the predictive power of inversions, companies, consumers, and investors will act as though we are headed into a recession, and thus create one in a self-fulfilling prophecy.

FINSUM: This is an interesting argument that relies strongly on the concept of herd mentality amongst investors. We tend to agree that an inversion may cause an adverse reaction in the economy and markets.

(New York)

A lot of investors are worried about the potential for an inverted yield curve, and not just because of what it could mean for markets and the economy. If you are holding long-term bonds that will be yielding less than shorter-term bonds, you are likely going to be incentivized to reshuffle your holdings. Accordingly, Citigroup has come out with a first of its kind product that allows retail investors to fully redeem the principal on their bonds if the yield curve inverts. According to Bloomberg the “30-year constant maturity swap rate can sink as much as 10 basis points below the two-year rate before holders start incurring losses”. Continuing, “The products pay a coupon and return full principal as long as the spread remains greater than that level”.

FINSUM: This seems a bit sophisticated for most retail investors, but it is definitely an interesting product and potentially a good one for hedging.

(New York)

Right now everyone seems to be focusing on the possibility of an inverted yield curve occurring between the 2 and 10-year Treasury. However, that might not be the best recession predictor after all. If you are strictly focusing on yields, then the 1 and 10-year is better, as it gives less false positives. But speaking more broadly, the M1 money supply and housing starts are other great places to look as both tend to peak well before a recession; M1 is usually about a year, and housing starts two years.

FINSUM: The reality is that if you take a broader view, things don’t look too bad. M1 is still growing, as are housing starts, so those indicators look healthy.