I get lots of emails and there are two questions I got so far this week that really are key questions for all of us.
The first is about the yield curve inversion that happened yesterday when the yield on the ten year bond fell below the two year bond. This is the most accurate indicator of a coming recession starting in 6-12 months from the signal hitting that there is. This inversion of the two and ten year bonds has preceded in fact before every single recession in the past 100 years.
One person asked:
Mike, what about Operation Twist? Didn’t the Fed intentionally invert the yield curve years ago for awhile? How is this indicator still valid with the Fed controlling the bond market (QE 1, QE 2, QE 3)?What am I missing?
No that didn’t happen back in 2012-2016 when these various QE programs were launched. Take a look a this chart which shows the actual yield curve. As you can see it only went below zero just this week and was above one during that time frame you are thinking about – so this inversion is new.
Now the last time this happened besides just now was back in 2006. So the stock market continued to go higher for almost a year after the signal hit. So I think that’s the best argument to make if you want to believe that it means nothing for the stock market.
My thinking is that it means a lot, but it isn’t really a perfect stock timing mechanism. It’s a huge warning sign though.
And that comes to my second question:
Question, if we are assuming a 2020 recession, doesn’t that mean a stock market downturn up to six months ahead?
I can’t find the article you wrote about it (long time ago).
It’s hard to predict the stock market based on just the yield curve inverting. At best it’s giving a six month window to time a coming top, because does the recession start six months from now or twelve months from now? In 2006 the stock market actually almost went up another year after the yield curve inverted although it had two fast 10% drops on the way.
I think it’s best just to watch the chart action of the stock market averages, the VIX, and the internal indicators to try to time the market.
Right now the market is dumping this month so if we get a panic washout then we can look for a bottom. Otherwise it’s all just guessing for me and guessing still can work great in a strong bull market, but is risky in a topping market, which is what I think this is in one form or another – with hopefully a rally for several months after a bottom this month.
All that said I heard people on CNBC say that this is all an anomaly and means nothing and so did Janet Yellen. “Historically, it has been a pretty good signal of recession, and it think that’s when markets pay attention to it, but I would really urge that on this occasion it may be a less good signal,” she said on Fox Business Network. “The reason for that is there are a number of factors other than market expectations about the future path of interest rates that are pushing down long-term yields.”
Their argument is that this is all due to foreign money flows thanks to interest rates being so low all over the rest of the world.
Of course I heard this exact same argument made back in 2006 too from Ben Bernanke and the US Treasury Secretary and they turned out to be wrong then. Back then they were saying the US is just the greatest place to invest in the world and money was going into bonds as a result keeping the long-term rates low.
And they were wrong. And what Yellen and these others need to explain is why did the yield curve invert so quickly in just the space of a few days this week?
I think we just need to stick with the charts and the obvious – which is that gold and silver have broken away from the stock market action and are outperforming the market averages – and that it is growing more risky now to have 100% of one’s money invested in the stock market. People can now get more interest from some of the big cap mining stocks than ten year Treasury bonds and we aren’t even in a recession yet!