Economic Health and the Yield Spread

[HVAU 673]

I've been following the bond market for about a year now.  The reading I've done, and my limited understanding, indicate that it's a reasonably effective tool for market predictions.  An increasing spread between the 2 year and 10 year bonds can predict market growth, while a diminishing spread can predict an upcoming recession.

Numbers from the Treasury Department show a spread curve that is rapidly flattening.  Here are the numbers for 2017 to current using data from the beginning of each:

1-17  1.23
2-17 1.26
3-17 1.17
4-17 1.1
5-17 1.05
6-17 .93
7-17 .84
8-17 .92
9-17 .81
10-17 .85
11-17 .76
12-17 .59

1-18    .54
2-18   .62
3-18   .59
4-18   .48
5-18   .47
6-18   .42
7-18   .3
Last  .29

There is a visual chart here: http://journal.firsttuesday.us/using-the-yield-spread-to-forecast-recessions-and-recoveries/2933/ 

*This site uses 10 year to 3 month comparison.  I used 10 year to 2 year as that is how I've most frequently seen the spread reported.

This article from investorolace.com investigates the idea that the yield curve may fail in it's predictive ability in the near term, but also states the following: 

"That is why an inverted yield curve has preceded every U.S. recession since 1960.

At the current time, the inverted yield curve is arising for several reasons. One, the Feds are hiking rates to offset rising inflation. Two, the Fed is unwinding its balance sheet at a fairly rapid rate. Three, trade tensions are rising. Four, we are ten years into the current economic expansion, and history says we are due for a pullback soon."

https://investorplace.com/2018/07/why-stock-market-keep-heading-higher-despite-inverted-yield-curve/

The author goes on to say that 19 months following an inversion is the right estimate for the stock market react to recession realities.  If I use the current trend in the curve to extrapolate the date of inversion combined with the author's 19 month cushion I should be able to predict when the market will react to recession realities.

The average loss in the spread from 1-17 to 7-18 (19 months) is .048 per month.  If that rate holds true inversion will occur in January of 2019.  The realities of recession will set in July of 2020.  

Using the average rate of loss in the spread over only the last 12 months (8-17 to 7-18) of .051 shows an inversion in December.  

Using the rate over only the last six months (2-18 to 7-18) of .53 indicates inversion also in December.

Using the rate over the last three months (5-18 to 7-18) of .56 shows an inversion in late November or early December.  The last three scenarios indicate the market recognizing recession realities in May of 2020.

I went through these calculations to illustrate that the approach of the inversion may be accelerating.  That acceleration will likely be affected by Fed rate decisions as well.  If that acceleration continues inversion and recession may move up a month or so.

Of course everything could change and the curve could stabilize, a recession not occurring for a few more years.

So what?  This isn't the economic smack talk board.

All of this is to point out the problems with Trump and company's economic agenda for the time being.

First, the tax cuts:

These tax cuts are hog's ass money.  The economy was peaking before the tax cuts were even passed.  Passing them increases the deficit significantly.  Combine the higher deficit with already low, though increasing to quell inflation, interest rates and we end up with a government with a weakened bag of tricks to minimize the recession.  

Second, "trade wars are easy to win":

Trump could be riding the high of an inherited, booming economy (thanks Obama), but he doesn't seem to have it in him to recognize his good fortune.  Instead, Trump has engaged in trade wars with China, Mexico, Canada, the EU, etc.  Now he's made overtures of an escalation to a currency war which may trigger dumping of US assets.

https://www.bloomberg.com/view/articles/2018-07-20/trump-s-trade-war-a-dangerous-new-front

https://www.cnbc.com/2018/07/20/trade-war-could-be-morphing-into-currency-war-if-china-is-plays-hardba.html

Third, the GOP agenda:

A major platform of Republicans is deficit reduction...doh.  They kind of shot their credibility there with that whole deficit increasing tax cuts, WealthCare reform.  So where do they turn?  Most predict that they'll focus on entitlements, social safety nets for those that can't retire on the dividends of their tax cut investments.  In essence there is a real likelihood that as those with more receive more, those with less will be left with much less protection in the probable economic downturn.

It's getting on in the evening and I'm sure I've left some stones unturned, but I should be on my way.  Of course I could be wrong in all of this.  Exponentially greater market watchers than I have failed at the prediction game.  You conservatives can choose to play defense on the issue, but maybe try to take this as a message if peace as well.  If things are going the way they quite possibly could and you've seen this post maybe you will protect your money and while doing so think to yourself "that HVAU sure is a center left son of bitch, but I'm glad I read that one post and was prepared to move my investments into a stable position".

Some more articles and links:

https://money.cnn.com/2018/03/28/investing/bond-market-yield-curve-wall-street/index.html

https://www.cnbc.com/2018/07/19/biggest-bond-market-risk-isnt-the-fed-versus-trump-or-rising-rates.html

https://money.cnn.com/2018/01/31/investing/alan-greenspan-bubble-stocks-bonds/index.html

https://www.foxbusiness.com/markets/bond-yield-curve-continues-to-flatten-are-we-headed-towards-a-recession

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

https://www.wsj.com/articles/flattening-yield-curve-raises-warning-flag-1524055903

https://www.wsj.com/articles/the-other-yield-curve-investors-should-watch-as-trouble-mounts-1529408536
 

 

 

[homersapien 11,513]

Very interesting.   Thanks for posting.

I've read about the portent of the inverted yield curve and I heard it discussed on "Wealth Track".

I have one question. (And I apologize for being lazy but it's easier to ask you than look it up.)  You wrote:

"The author goes on to say that 19 months following an inversion is the right estimate for the stock market react to recession realities.  If I use the current trend in the curve to extrapolate the date of inversion combined with the author's 19 month cushion I should be able to predict when the market will react to recession realities."

My question is how is "inversion" defined? 

Or to put it another way,  at what point during the trend do you start counting off the 19 months until a market reaction?

 

[HVAU 673]

My understanding is that inversion occurrs once long term yield rates are lower than short term.

[homersapien 11,513]

36 minutes ago, HVAU said:

My understanding is that inversion occurrs once long term yield rates are lower than short term.

Yeah, I went back and read it and that's what I got also. 

So, the question becomes will your extrapolation indicate an inversion - kind of hard to predict otherwise - and if so, how accurate will the 19 month "lag" prediction be. I wonder if Trump's tax cut and attack on regulations will pump the market enough to increase that lag and if so, will that make the ultimate recession deeper?  

I also wonder just how far Trump is willing to go with his trade war and what effect that may have on the timing of the next recession. 

 

[homersapien 11,513]

BTW, This is a really interesting thread and I think it belongs in the serious discussion forum.

Monitors?

[HVAU 673]

2 hours ago, homersapien said:

Yeah, I went back and read it and that's what I got also. 

So, the question becomes will your extrapolation indicate an inversion - kind of hard to predict otherwise - and if so, how accurate will the 19 month "lag" prediction be. I wonder if Trump's tax cut and attack on regulations will pump the market enough to increase that lag and if so, will that make the ultimate recession deeper?  

I also wonder just how far Trump is willing to go with his trade war and what effect that may have on the timing of the next recession. 

 

The yield curve seems to represent the investment professionals'  intuitions about the strength of the economy in the middle term.

I'm not sure if the tax cuts will have an effect, other than what it is already having, on the timing of a recession.  The bigger issue with the tax cuts is the increase in the deficit which weakens the government's ability to manage recessions.

I doubt deregulation in industry will have a great, downward effect on the recession, but deregulation of the financial market, like the repeal of the fiduciary rule and Dodd-Frank Act rollbacks may or may not be encouraging the sort of unethical trade practices revealed in the last recession.  If it is it will obviously weaken the economy further as investor confidence takes a bigger hit.

[HVAU 673]

On the trade war, I think it could also weaken the government's ability to deal with recession if our trade partners have installed agreements with other nations.  On the other hand, if Trump would alter or, at least, moderate the trade war push a recession may be delayed for a few more years.

[shabby 1,958]

Just chiming in to say thanks for a good read. I don't know enough about the topic to add to it but it was very interesting to say the least

[AU64 10,122]

20 hours ago, HVAU said:

It's getting on in the evening and I'm sure I've left some stones unturned, but I should be on my way.  Of course I could be wrong in all of this.  Exponentially greater market watchers than I have failed at the prediction game.  Y

Thanks for the post and links....and like you I'm an amateur but an old one who has been managing his retirement funds for quite a few years.   And.....I've watched bear market predictors cost their clients huge amounts of money by giving investment advice based on technical analysis that usually recommended loading up on bonds and of course,  those prognosticators who gave advice after the recent election that a recession was imminent.  .   

I guess if you are a trader rather than an investor and your time-frame is short, then there might be some merit in trying to outguess the market though trying to outguess recent markets has been a fools errand since big market swings have been based more on emotional things like DT's crazy tweets or "trade war" rumors.... and less on good economic performance.     Just my view, but I'm glad to see the Fed trying to normalize interest rates and getting out of the business of propping up the stock market.  Even progressives voiced concerns about that …. http://occasionalplanet.org/2014/10/30/why-is-the-stock-market-soaring-when-the-real-economy-is-on-its-knees/

https://www.zerohedge.com/news/2016-06-07/fed-outright-buying-stocksfutures-prop-markets

And of course, this great piece of crystal ball gazing....    https://www.forbes.com/sites/nathanvardi/2016/12/05/trump-economic-plan-would-send-u-s-economy-to-most-severe-recession-since-early-1980s/#1d4a3cda7d25

And one other opinion point...no matter how much you know or think you know, you can't out smart the program traders and their virtually instantaneous reaction time in the market. 

JMO but taking into account your age and retirement plans, develop a balanced portfolio that won't cause you to lose sleep ….and where you will not need to jump up each morning to see what DT has tweeted, or some dem has said in response in order to "protect your investments".     Good luck.    

[HVAU 673]

35 minutes ago, AU64 said:

JMO but taking into account your age and retirement plans, develop a balanced portfolio that won't cause you to lose sleep ….and where you will not need to jump up each morning to see what DT has tweeted, or some dem has said in response in order to "protect your investments".     Good luck.  

To your point about bear market predictors, absolutely.  Although I did see some bulls give some stinkers around 2007.

We're definitely in long game mode for our retirement savings.  I've got a daughter that is not too far away from using her 529.  I have moved to a more conservative position for that, but we're definitely not ready to jump ship on the stock market just yet.  

I'm rooting to make more money, but given my political leanings and demand-side philosophies the future of this market could be illuminating, having the potential to further substantiate my ideas or weaken me adherence to them.

 

[Proud Tiger 4,261]

It is a reasonable yardstick but not 100% accurate by any means. If you play the market don't bet the farm on it. There are a lot of other factors and a lot depends on which stock(s) you follow. Personally I never invest in bonds but to each his own.

[SaltyTiger 7,908]

5 minutes ago, HVAU said:

We're definitely in long game mode for our retirement savings.

Stay there and you will do well HVAU. Think you commented that you are only forty.  

[AU64 10,122]

30 minutes ago, Proud Tiger said:

It is a reasonable yardstick but not 100% accurate by any means. If you play the market don't bet the farm on it. There are a lot of other factors and a lot depends on which stock(s) you follow. Personally I never invest in bonds but to each his own.

Agree...was disappointed that my son...age 53 was advised by his Fidelity guy to have about 30% in bonds....just went through a divorce and has about half of his original "estate" now and needs a more of a growth plan than what bonds could provide over the next 15 years or so. ...and that was recent advice which blew my mind.  

Since retirement, I've rarely been less than 80% in equities and a few high yield bonds for income purposes....though I keep more cash now....at least a year's worth.    I rarely buy individual stocks....more into ETFs  and try to track sectors more than individual companies....and generally I bet on the US economy which despite ups and downs, has a very good long term track record.    Now of course I'm having to take my required distribution whether I need it or not.....Uncle Sam is gonna get his sooner or later but you sure can't beat compound interest on a tax deferred investment plan over 20  or 30 years.   . 

What folks have to remember is that they are likely to be retired almost as many years as they actually worked so unless they have really stacked the money away, you have to plan on "earning" a reasonable income even during retirement years.   Anyone taking the conservative route the past ten years has likely not kept up with they cost of living.   And trying to predict the ups and downs mostly makes money for those doing the predicting and not necessarily  folks like us who might be taking their advice.   JMO....

[homersapien 11,513]

14 hours ago, AU64 said:

Thanks for the post and links....and like you I'm an amateur but an old one who has been managing his retirement funds for quite a few years.   And.....I've watched bear market predictors cost their clients huge amounts of money by giving investment advice based on technical analysis that usually recommended loading up on bonds and of course,  those prognosticators who gave advice after the recent election that a recession was imminent.  .   

I guess if you are a trader rather than an investor and your time-frame is short, then there might be some merit in trying to outguess the market though trying to outguess recent markets has been a fools errand since big market swings have been based more on emotional things like DT's crazy tweets or "trade war" rumors.... and less on good economic performance.     Just my view, but I'm glad to see the Fed trying to normalize interest rates and getting out of the business of propping up the stock market.  Even progressives voiced concerns about that …. http://occasionalplanet.org/2014/10/30/why-is-the-stock-market-soaring-when-the-real-economy-is-on-its-knees/

https://www.zerohedge.com/news/2016-06-07/fed-outright-buying-stocksfutures-prop-markets

And of course, this great piece of crystal ball gazing....    https://www.forbes.com/sites/nathanvardi/2016/12/05/trump-economic-plan-would-send-u-s-economy-to-most-severe-recession-since-early-1980s/#1d4a3cda7d25

And one other opinion point...no matter how much you know or think you know, you can't out smart the program traders and their virtually instantaneous reaction time in the market. 

JMO but taking into account your age and retirement plans, develop a balanced portfolio that won't cause you to lose sleep ….and where you will not need to jump up each morning to see what DT has tweeted, or some dem has said in response in order to "protect your investments".     Good luck.    

I agree completely.  Market timing is a terrible investment strategy.  Better to manage your allocation and just ride.  You'll lose money trying to time the market.

The thing I harp on with younger folks is the value of time -  start early, and you cannot fail over the long haul.  The mathematics dictate it.

[HVAU 673]

I've been out of the loop for a bit, but I said I'd keep up on this thread so I thought I'd update the yield curve data.

The beginning of August saw the curve spread widen (.330) a sign of strengthening conditions.  However, by mid-August the flattening continued with the spread falling back to .250.  At the moment the curve spread sits at .220 according the the Treasury data, but CNBC, which tracks the bond markets in quasi-real-time shows the spread at .203. It had fallen into the .190's before the US-Mexico trade agreements were announced. 

These numbers fall in line with the prediction calculations I indicated previously, and support the notion that a yield curve inversion is probable in December or January.  If history repeats this inversion indicates a recession by mid-2020.  

There are, of course, other guideposts that support and contraindicate this prediction.

[aubearcat 2,138]

On 7/22/2018 at 8:49 PM, SaltyTiger said:

Stay there and you will do well HVAU. Think you commented that you are only forty.  

I’m not nearly as close to retirement as I’d like but I am investing about as much of my income as I can in to a couple of options offered through my job (RSA-1 and a Nationwide managed investment account). The RSA-1 system is pretty static and I can really only decide how much to contribute. The Nationwide account I can decide many more options. For example, it’s all going into a moderately aggressive situation where all is based off of the market. I moved it from a conservative investment when the market was rebounding and now I’m almost tempted to move it back. This is definitely food for thought but I’m definitely not market savvy enough to do it without sound advice. 

[homersapien 11,513]

7 minutes ago, aubearcat said:

I’m not nearly as close to retirement as I’d like but I am investing about as much of my income as I can in to a couple of options offered through my job (RSA-1 and a Nationwide managed investment account). The RSA-1 system is pretty static and I can really only decide how much to contribute. The Nationwide account I can decide many more options. For example, it’s all going into a moderately aggressive situation where all is based off of the market. I moved it from a conservative investment when the market was rebounding and now I’m almost tempted to move it back. This is definitely food for thought but I’m definitely not market savvy enough to do it without sound advice. 

You might want to consider index funds, like an S&P 500 index instead of such managed mixed funds to cover most of your equities needs (70-80% IMO, depending on your risk tolerance and age).   It would make it easier to determine your allocation, and the loads are much lower.

[HVAU 673]

39 minutes ago, aubearcat said:

I’m not nearly as close to retirement as I’d like but I am investing about as much of my income as I can in to a couple of options offered through my job (RSA-1 and a Nationwide managed investment account). The RSA-1 system is pretty static and I can really only decide how much to contribute. The Nationwide account I can decide many more options. For example, it’s all going into a moderately aggressive situation where all is based off of the market. I moved it from a conservative investment when the market was rebounding and now I’m almost tempted to move it back. This is definitely food for thought but I’m definitely not market savvy enough to do it without sound advice. 

I'm just following trends for the fun of it.  We're invested in a government retirement account, and we have our children's college savings accounts. 

We've moved to a conservative strategy for the kids as they're getting closer to graduation (still a bit out though), and I believe we're close to topped off in the market.  I'm ok with not riding the wave too high, but if the market turns down as I believe it will, I don't want to be left paying cash or financing my kids' college.

 

[aubearcat 2,138]

1 hour ago, homersapien said:

You might want to consider index funds, like an S&P 500 index instead of such managed mixed funds to cover most of your equities needs (70-80% IMO, depending on your risk tolerance and age).   It would make it easier to determine your allocation, and the loads are much lower.

I’m mid 40s and will be mid 50s when Im eligible for retirement. I’m going to add more to my retirement deductions the closer I get to eligibility. At the moment everything in those accounts are good but as the mid 00’s showed us, that can change quickly. I appreciate the information. I’m definitely going to have to educate myself more about my options. 

[AU64 10,122]

2 hours ago, aubearcat said:

I’m mid 40s and will be mid 50s when Im eligible for retirement. I’m going to add more to my retirement deductions the closer I get to eligibility. At the moment everything in those accounts are good but as the mid 00’s showed us, that can change quickly. I appreciate the information. I’m definitely going to have to educate myself more about my options. 

Time is your best friend when investing....and JMO but waiting until you can afford to save for retirement is not a good plan.  A smaller amount over many years can work wonders and as many have opined, trying to time the market is generally a sucker's bet.   

By and large if you have access to a 401k with some kind of matching feature you should do the max you can figure out how to handle  since that is "free" money.   I am mostly an ETF person and find that VIG and VONE are good index type funds that are pretty much  a bet on the US economy.   Agree with Homer on what you might invest in Equities....even more at your age.   Consider that even after you retire, unless you have a few million saved,  you will probably need to earn money from your investment for another 20- 30 years perhaps …..and even as the market yoyos you will have time to ride out the variations.   

JMO but I keep about 3 or 4 years  of my normal living expenses in non-volatile accounts and adjust as the market allows.....but I try to be in a position where I never must remove money from my accounts to live on when the market is bad. ...work out a plan to take it when you want to and it's profitable...not when you have to take a loss just to get some cash.   

Good luck....retirement can be great.....if you have enough to live comfortably on. 

[aubearcat 2,138]

5 minutes ago, AU64 said:

waiting until you can afford to save for retirement is not a good plan.  A smaller amount over many years can work wonders and as many have opined, trying to time the market is generally a sucker's bet.   

 

I’m at about 1k a month extra that I’m adding to my investments outside of my job’s contributions (I have 4 kids, that’s about all the extra I can do right now). The second part about attempting to time the market is what my financial advisor said was impossible to do. I suppose I hear the horror stories of people losing everything due to the market crash and get a little antsy. 

[AU64 10,122]

2 minutes ago, aubearcat said:

I’m at about 1k a month extra that I’m adding to my investments outside of my job’s contributions (I have 4 kids, that’s about all the extra I can do right now). The second part about attempting to time the market is what my financial advisor said was impossible to do. I suppose I hear the horror stories of people losing everything due to the market crash and get a little antsy. 

Sounds to me like you are doing very well with what you are investing.   Getting antsy is what gets most novice investors in trouble.  

As noted, time is your best ally …..and a laddered investment plan such that you can afford to wait out the droughts.    Although I used to do it, seems to me the worst habit you can have is to look at your account balance (or price of your stock) every day or two.     Finally I realized that I had to be in for the long haul and if it went up a bunch, I was not going to sell it.....and if it went down, I was not going to sell it either.  So gradually I mostly broke the habit.   

I do keep "stop loss' positions on some of the more volatile ETFs ( my betting money) that I don't consider long term investments.....so if I have made a nice profit and they then  take a turn for the worse, they get sold automatically and I can protect some of the profit.    

Because, you put money in on month schedule, you get a levelling result  and if you keep it up for a number of years, you are buying more shares in down markets that will likely return to it's norm over time and rise with the general economy.    JMO but that is about the best one can do. 

Good that you have a financial advisor but the more you know the better.   If you are like me....nobody cares as much about my retirement money as I do....and professional advisors are probably more conservative than I am...….I do push it a bit considering my age.  

[homersapien 11,513]

3 hours ago, AU64 said:

Time is your best friend when investing....and JMO but waiting until you can afford to save for retirement is not a good plan.  A smaller amount over many years can work wonders and as many have opined, trying to time the market is generally a sucker's bet.   

By and large if you have access to a 401k with some kind of matching feature you should do the max you can figure out how to handle  since that is "free" money.   I am mostly an ETF person and find that VIG and VONE are good index type funds that are pretty much  a bet on the US economy.   Agree with Homer on what you might invest in Equities....even more at your age.   Consider that even after you retire, unless you have a few million saved,  you will probably need to earn money from your investment for another 20- 30 years perhaps …..and even as the market yoyos you will have time to ride out the variations.   

JMO but I keep about 3 or 4 years  of my normal living expenses in non-volatile accounts and adjust as the market allows.....but I try to be in a position where I never must remove money from my accounts to live on when the market is bad. ...work out a plan to take it when you want to and it's profitable...not when you have to take a loss just to get some cash.   

Good luck....retirement can be great.....if you have enough to live comfortably on. 

I recently created a 5 yr CD ladder with $250K, simply for piece  of mind. But I wouldn't have done that at age 50.

[homersapien 11,513]

4 hours ago, aubearcat said:

I’m at about 1k a month extra that I’m adding to my investments outside of my job’s contributions (I have 4 kids, that’s about all the extra I can do right now). The second part about attempting to time the market is what my financial advisor said was impossible to do. I suppose I hear the horror stories of people losing everything due to the market crash and get a little antsy. 

Don't worry about the market, worry about keeping your marriage together.

A divorce would have WAY more impact on your financial future than a market drop. 

Live beneath your means (avoid debt), invest the difference as early as you can, and you can't help from becoming become wealthy.  That's all the strategy you really need. (Well accept for not being overly conservative in your allocation.)

[AU64 10,122]

1 hour ago, homersapien said:

I recently created a 5 yr CD ladder with $250K, simply for piece  of mind. But I wouldn't have done that at age 50.

agree....was just suggesting how to do a long range plan when it is necessary to stay invested even after retirement.    JMO but unless you have  a bunch of money …which we did not, you have to continue to depend on investment income through your retirement years....and can't just set into CDs (at 3% or less) or corp bonds.