Back in March, I wrote about how the bond market was inverting and sending a serious warning signal. Every recession since World War II has been predated by an inversion of the yield curve, and there have only been one or two “false positives” in which the yield curve inverted and there was no official recession that followed.
I say one or two because yield curve inversion can be measured a couple different ways. For example, some analysts look at the relationship between the 3-month yield and the 10-year yield, while others focus on the relationship between the 2-year yield and 10-year yield. For our purposes, we’re comparing the 3-month yield to the 10-year yield as this is considered by many to be the most accurate at predicting recessions.
Well, the inversion came and went. The yield curve “righted” itself in April, with the 10-year yield rising slightly and the 3-month yield falling slightly. It was still an exceptionally flat yield curve. That isn’t a sign of confidence, but at least it wasn’t technically inverted.
After a brutal May in the stock market that saw investors jump ship for the relative safety of the bond market, the inversion is back. At 2.25%, the yield on the 10-year Treasury is significantly lower than the 2.37% on the 3-month bill.
Now, there are differing opinions here. As I mentioned earlier, some say the “real” yield curve inversion is when the 2-year yield goes higher than the 10-year, as this is less influenced by Fed policy.
Frankly, I’m not interested in splitting hairs. Like most economic indicators, this is a broadsword, not a surgical scalpel. It’s designed to give us a rough idea of the macro environment we’re in, not pinpoint the exact date of a recession with perfect precision. And the message is very clear. The bond market sees trouble ahead.
It’s also worth noting that the bond market and stock market have been telling very different stories throughout 2019. Stocks sprung higher in a V-shaped recovery that saw them recoup all of last year’s losses and even hit new highs.
But bond yields didn’t rise, which is what you would expect in a healthy economy with normal inflation expectations. Bond yields have trended lower this entire calendar year.
That’s not necessarily a bad thing though, if you’re positioned for it.
The Upside to Inversion
A portfolio that benefits from falling yields — like that of Peak Income — tends to have picks more influenced by the bond market than the stock market. And falling bond yields mean rising bond prices… and rising prices for bond substitutes.
Peak Income is loaded up with high-yielding stocks, REITs, MLPs, and other income-focused investments that tend to be sensitive to moves in the bond market. With bond yields trending lower — and looking to stay lower if the economy cools — these are precisely the kinds of investments you want to own. Lower market yields make the higher yields on these investments all the more attractive.
Though these types of portfolios aren’t completely immune from the turmoil in the stock market. For the most part, they’ve avoided most of the recent market turmoil, treading water rather than dropping along with the S&P 500.
And I call that a success.
Anyway you spin it, this isn’t a fun market to be in right now. The best thing to do is have a well-positioned portfolio.