Sunday, June 24, 2018

Inverted Yield Curve , Recession, and Market Top

When will stocks peak out?  That's the million dollar investment question. Based on The Mad Hedge Fund Trader, who has 12,098 followers on Seeking Alpha, his predication of stock top could be on:
Friday, May 10, 2019 at 4:00 PM EST
His predication is based on the following reasoning:
  • Inverted yield curve could be created in December 2018
    • Assume that the Fed continues “normalizing” interest rates by raising 25 basis points a quarter for the next five quarters.
  • This has a recession beginning 14 months after the December 15, 2018 Fed meeting, or February 2020.
    • Over the past 100 years, inverted yield curves have had an average life of 14 months, within a range of nine to 19 months.
  • Historically, stock markets peak exactly 7.2 months before a recession, so this takes us back to August 2019.
  • Back out three more months for a “Sell in May and go away” effect
  • Bear markets usually begin on Black Mondays
    • Because investors are prone to digest deteriorating market technicals and fundamentals over a weekend and then panic at the first opportunity.
Add all this together, and the analyst arrives at his target market peak of 
Friday, May 10, 2019 at 4:00 PM EST
In this article, we will cover the following topics:
  • What's yield curve?
  • Three types of yield curve sloping
  • Inverted yield curve

US Treasury Yield Curve


Yield curve represents the relationship between interest rates on bonds of different maturities, but equal credit quality. For our purposes, we'll be discussing the
US Treasury yield curve
One of the most reliable ways of predicting future economic growth has been to look at the difference between
  • 10-year and 2-year bond yields or
  • 10-year Treasury Note and the 3-Month Treasury Bill

Steep Yield Curve


Flat Yield Curve



Inverted Yield Curve



The Slope of the Yield Curve 


Conceptually, the slope of the yield curve is a rough approximation of the stance of U.S. monetary policy. The Federal Reserve controls the level of short-term interest rates. Markets determine the level of long-term interest rates based on underlying macro fundamentals. 

Therefore, the slope of the yield curve can tell us a lot about the market's expectations for economic growth and inflation.  There are three basic shapes the yield curve can take:
  • Normal, upward sloping yield curve
    • Economy is growing and investors are confident
    • Steep yield curve
      •  A sharply upward sloping, or steep yield curve, has often preceded an economic upturn
      • Steep yield curve that is so beneficial to banks and levered bond investments.
  • Flat yield curve
    • Warning sign that an economy is under duress
  • Inverted yield Curve
    • The economic outlook is very bleak

Inverted Yield Curve Precedes the Recession



Inverted  Yield Curve 


The Fed's ongoing rate hiking will eventually trigger the next recession.  Historically, an inverted yield curve - the difference between 10-year and 2-year bond yields - has been one of the single-best leading indicators of an impending downturn.

At first, rising interest rates INCREASE borrowing dramatically, which will force investors scramble to beat the move.  They make up for shrinking profit margins caused by higher rates by increasing size.  In this period, you often see 
  • Stock markets accelerate their appreciation
  • Lots of business soliciting letters from banks or credit card companies.  This is already happening in a major way.
When the curve inverts, the bond market is sending a warning sign that the Fed has set short-term rates above what is justified by fundamentals (i.e., it has moved to a restrictive policy stance). The curve has been flattening recently and the current spread between the 10-year and 2-year Treasury note is only about 34 basis points.

When the return finally turns negative, investors then dump EVERYTHING, causing interest rates to explode, igniting a recession.  That’s when 10-year Treasury bonds spike to 4%, or even 5%.


References

  1. Cleveland Financial Stress Index
  2. Fed "Workhorse" Model Says Odds of Recession in Next Year Only 3.56%; What are the Real Odds?
    • The report failed to mention the most practical of practical issues: It's damn hard for the 3-month to invert with 10-year treasuries when the Fed has artificially held short-term yields closet to zero.
  3. The Yield Curve as a Leading Indicator: Some Practical Issues (New York Fed)
  4. The Yield Curve as a Leading Indicator (New York Fed)
  5. Looking Beyond Circular Feedback Loops In The Market
  6. On The Dispersion, Or Lack Thereof, of Economic Weakness (Tim Duy's Fed Watch)
  7. So You Think A Recession Is Imminent, Yield Curve Edition  (Tim Duy's Fed Watch)
  8. So You Think A Recession Is Imminent, Employment Edition (Tim Duy's Fed Watch)
  9. 3 Charts All Investors Should See
    • US credits
    • Global sector earnings momentum 
    • Global manufacturing activity
  10. VIX Outside of `Red Zone' Indicates No Recession, Goldman Says
    1. The “Red Zone” happens when the VIX is above 25 and climbing, which historically coincides with flat or negative U.S. gross domestic product.
  11. A hedge fund manager shares the 10 things that could surprise the market this year (good)
  12. A Recession Is On My Mind (Steven Hansen)
  13. The Yield Curve Says No Recession
  14. Labor Indicators: Some of Today's Trends Pre-Date the Great Recession (Fed Reserve Bank of St. Louis)
  15. Why Is Economic Growth So Slow?
  16. Portion of US Treasury Yield Curve Inverts
  17. Altitude Adjustment: Investing During a Period of Lower Returns and Higher Volatility (PIMCO)
    • We expect less consistency in the negative correlation between stocks and bonds relative to the past decade.
    • We believe currency movements will play a much larger role in determining portfolio outcomes. 
    • We suggest investors not ignore the reduction in market liquidity and its potential consequences.
    • Our outlook for the global economy is for sideways growth with an uptick in inflation.
    • Are we nearing the threshold of the next global recession? At PIMCO, we don’t think so.
  18. Currency Wars and a Job Gain Recession?
  19. The yield curve still works and 5s10s is one measure that is less influenced by the Fed. 
  20. Worthy Of Investor Attention: The Long-Term Debt Cycle
  21. 22 Signs That The Global Economic Turmoil We Have Seen So Far In 2016 Is Just The Beginning
  22. Smelling the Recession
  23. Voluntary Job-Quitting Hits Highest Level in Nine Years
  24. 13 Charts On The Likelihood Of A Recession
  25. Inflation And GDP Growth Rise; Bond Yields Must Follow
  26. The 10 Largest “Relative” Trade Networks (EAST ASIA, EUROPE, INDIA, NORTH AMERICA )
  27. Singapore's export slump is a worrying sign for the global economy
    • As a global barometer for the health of the global economy, Singapore continues to paint a bleak picture at present.
  28. Dual Risk Out Of China (04/24/2016)
  29. Weak Eurozone Manufacturing Data Reinforces ECB's Impotence
  30. These 9 charts explain the global slowdown and why central banks are powerless
  31. An Arbiter of Recessions Sees ‘Clouds on the Horizon’ for the U.S. Economy
  32. One of the biggest warning signs of the financial crisis is flashing again — but this time is different
    • An increase in the Libor, the typical thinking goes, means that banks see lending to their fellow financial institutions as more risky and signals the possibility of financial instability.
  33. Surge in Global Economic Surprises, Business Confidence Continues
  34. Hard-Boiled vs Soft-Boiled Economic Egg Debate: Cracking the Shells
  35. Closing In On ZERO Growth
  36. Sotheby's As Economic Indicator
    • While Sotheby's caters mostly to people who have too much money lying around that they feel the need to spend it on paintings and pricey tchotchkes, in the past the stock's performance has been cited as a relatively good predictor of the business cycle. 
  37. Taking Stock (Tim Duy)
  38. Here's The Biggest Threat To The Economy And The Bull Market (good)
  39. Are Recession Risks Increasing In The U.S.?
  40. Why The Stock Market Will Peak On May 10, 2019 At 4:00 PM EST
  41. Investment Basics: Yield Curve (Pimco)