Curve Inversion & You

Implications of yield curve inversions.

As I start to write this post shortly before the market close on March 22, 2019, the three month US T-bill has a microscopically higher yield than the the Ten Year US Treasury Note. This is the definition of a yield curve inversion and it is potentially serious but, it is not serious now or maybe yet is a better word.

The basic implication of an inverted yield curve is that it impacts how capital is accessed for expansion. If access to capital is impeded then it becomes harder to grow which leads to a recession. The whole reason the Fed took such desperate measures during the financial crisis was to try to make capital readily available in hopes it would stimulate growth.

Banks borrow money at low, shorter term rates like the kind available in savings accounts and lend out at higher, longer term rates like for a mortgage or plant expansion. A flat curve makes this less profitable and an inverted curve potentially makes it a money loser. This is what makes yield curve inversion an indicator of economic recession.

Recessions have the tendency to be bad for the stock market and I would not expect it to be any different whenever the next recession happens. Today is day one of the inversion. For all we know this might be the only day or maybe it will resolve next week and then start to steepen back to "normal." That is not a prediction, I have no idea, but it is important to zoom out a little and realize what we are actually talking about; access to capital is threatened and that becomes recessionary...after a few months.

I don't think there is any need to get defensive today based solely on the curve being inverted for a few hours. Bear markets start slowly, giving you plenty of time to take defensive action and this is supported by the history of yield curve inversions leading to recession several months later...historically.

If somehow this time is different and a large multi-month decline starts on Monday and you're still fully invested, what then is the consequence? Time is the consequence; waiting. Often repeated theme from me coming now: Bear markets are all the same, the go down a lot and scare the hell out of people, then it stops going down (often for no real reason) and then it goes back up and makes a new high. The only variable is how long that all takes. If you don't believe this then you should have gotten out of equities long ago.

If you read that and are worried about an adverse sequence of returns for portfolio income purposes (like you're newly retired), that is more an asset allocation issue than a market issue. A suitable asset allocation is a higher priority IMO than returns.

I've been around for several inversions now and every time it has happened before there was a parade of pundits on stock market television telling us why it was different...and it wasn't. Earlier in this cycle when the curve was merely getting flatter there was a parade of pundits on stock market television why now is different. As I Tweeted this morning, I would not give a persistent curve inversion the benefit of the doubt.

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