Our markets experienced a tough day on Wednesday, as the yield on the 10-year Treasury Bond broke below the 2-year  rate, an odd bond market phenomenon that has been a reliable indicator for economic recessions. The yield on the 30-year Treasury Bond closed at a record low on Wednesday.  This scenario is called an Inverted Yield Curve.  A Treasury Bond is much like a Certificate of Deposit (CD), except it is issued by our Federal Bank/Treasury instead of a community bank.  It provides the promise of a fixed interest rate and is available in 2-year, 10-year and 30-year duration.

There have been five yield curve inversions of the 2-year and 10-year yields since 1978 and all were precursors to recessions, but there is a significant lag.  Recessions occurred, on average, 22 months after the inversion. And the DOW enjoyed average returns of 15% 18 months after an inversion.

The last time this key part of the yield curve inverted was in December 2005, two years before our recession.

Our thoughts:

  • Although the yield curve has been a good indicator of future market performance, there are many market indicators that have falsely predicted market behavior over the past several years.  For example, the “Santa Claus rally” which Wall Street counts on every December did not present itself last year, as our markets were down 9% last December.
  • Notice how market performance is reasonably strong for 18 – 22 months after a yield curve inversion.  We risk re-positioning our portfolios and reduce risk by too much, so that we miss out on a potentially significant market rebound.
  • Our markets are up this morning to partially offset yesterday losses.
  • The bond market was up yesterday as well as did the consumer staples/dividend paying stock sector held up relatively well.
  • Patient investors will be rewarded for riding through these markets.

As always, please call us if you have any questions.