Dear Clients and Friends,
At 401(k) Engineers, it is very important to us that you are well informed about what’s happening in the markets. Here are a few of the key topics of conversation that we feel deserve the most attention this month. If you have any questions or would like to continue the conversation, let us know, and we appreciate the opportunity.
The 2 to 10-year yield curve inversion
What’s happening?
The yield on the benchmark 10-year Treasury note broke below the 2-year rate, a “canary in the coal mine” scenario that has historically preceded every recessionary environment since 1978. The 10-year Treasury note yield fell as low as 1.574%, briefly trading around 1 basis point below the yield on the 2-year note. Ultimately, the inversion was short-lived with the 10-year treasury yield closing higher than the 2-year.
This phenomenon occurs when two trends emerge:
- The bond markets believe interest rates will fall in the future as the Fed or economic forces attempt to create stimulus
- Investors sell equities and buy bonds, which drives up bond values and therefore pushes longer-term rates down
While certainly concerning, a recession takes an average of 22 months to develop from this indication point.
What does this mean for you as investors?
Interestingly enough, the inversion of the yield curve is usually followed by gains in the S&P 500. Since 1978, the 18 months following a 2-10 inversion the market rises an average of 15%. This chart shows the last three inversions to the top of the economic cycle.
What’s different this time?
Questions related to the unintended consequences of the Fed’s balance sheet unwinding, previous interest rates hikes by the Fed, negative global bond yields, and the late-stage tax cuts of 2018 are fueling speculation that this yield curve inversion is “manufactured” and harmless. However, a large number of economic data are indicating a slowdown and add credence to the narrative that this inversion is a real warning sign that must be heeded. Both views are likely correct.
What are our algorithms thinking?
At 401k Engineers, we are fact-based. The facts are we have several economic data points that are concerning – not just the yield curve inversion. However, we are not in a “danger zone” that shows we are at a statistically significant risk of a recessionary market environment with sustained asset value losses, but that could change in the coming weeks based on the level of volatility seen in recent days and the uncertainty surrounding China.
Our opinion is investors should continue to be invested at their comfortable risk tolerance and in-line with the needs of their financial plan. We do not recommend reducing risk below a normal risk tolerance at this stage.
The views expressed here reflect the views of Brian Peardon. These views may change as market or other conditions change. Actual investments or investment decisions made by Cambridge Investment Research and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon and risk tolerance. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Moody's Corporation is the holding company that owns both Moody's Investor Services, which rates fixed income debt securities and Moody's Analytics, which provides software and research for economic analysis and risk management. Securities offered through registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Advisory services offered through Cambridge Investment Research Advisors, Inc., a registered Investment Adviser. 401k Engineers and Cambridge are not affiliated. CA Insurance Lic. #0E44645