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Mitch writes this blog for Resolute Wealth Management, LLC, and some of the content within this blog are opinions on financial products and/or securities that may not reflect the opinions of the firm or be applicable to everyone’s situation. If you have questions about whether this content applies to your specific situation, please reach out to Mitch directly at firstname.lastname@example.org.
Last week, the yield curve of government rates “inverted.” Since then, that’s been the hot topic of the financial news media, all rushing to give their opinions on what it means, why it should matter, and why it shouldn’t. Why should you care as an investor? The yield curve can be a powerful leading indicator of where the economy is headed and we should understand it. It’s also important to understand its limitations and remember that it’s a strong data point to consider when we are thinking about where the economy is going, but it isn’t always a perfect indicator. If it were, we’d just sell all of our investments whenever it inverts and buy them back when it returns to a normal upward slope.
An Inverted Yield Curve
The yield curve is a graph of the spot rates on U.S. Treasuries of various time horizons, from as short as 30 days to as long as 30 years. A normal yield curve would naturally be upward sloping, because we take risk when we buy bonds, and if we have to hold those bonds for longer periods of time, we want to be compensated more for taking on that risk of a longer time period. When rates on shorter term bonds become higher than the rates on longer term bonds, the curve becomes downward-sloping or “inverted.” The popular measure of that curve is the difference in rates between 10 year bonds and 2 year bonds, called the “10/2 spread.” This is the spread that inverted last week. However, various other spreads exist and are tracked, such as the 30 year/2 year, 10 year/30 day, and 30 year/30 day. Not all of these spreads will go “negative,” signaling inversion, at the same time, creating confusion as to whether the spread is actually inverted or not (depending on who you listen to).
Why Does the Curve Inverting Matter to Me?
The theory behind an inverted yield curve is that when shorter rates are higher than longer rates, it reflects a poor long-term outlook for the economy. Typically, an inverted yield curve is signaling that the economy is slowing down and potentially headed into the recession part of the business cycle. Our economy goes through a cycle of phases, where it contracts during a recession, then hits a recovery phase, turns around and grows at a good pace, before slowing down and eventually returning to a recession phase again. Recessions are part of the economic process; while they don’t sound fun, they are part of a naturally occurring business cycle.
So, We’re Going Into A Recession Then?
Not necessarily! The truth is that there isn’t a human on the planet that can tell you which way an equity or bond market will go. The reality is that these are “signals.” The 10-2 spread turning negative is a powerful signal, and it has successfully predicted downgrades in the market in the past. However, these recessions have taken time to develop, from 6 months from the spread first inverting to 2 years. It’s also important to remember that it’s not the only economic indicator we look at when determining market direction. The stock market, orders for durable goods (e.g. cars, furniture, appliances), manufacturing jobs, and building permits (orders for new home construction), are all considered leading economic indicators that gives us a picture of where we are in our economic cycle.
What Do I Do Then?
I don’t give the standard finance answer to clients here, which would be “it depends?” As an advice-giving financial consultant, I spent all sorts of time with my client learning about their goals and risk appetites, then constructed a portfolio of assets for them that I feel fits best with their LONG-TERM goals. Changing the process for different market views goes against the very reason we set up the portfolio in the first place! While I change the weights of some of the positions in the portfolio to adjust to what we think are the current market themes, a pending recession doesn’t mean I completely run out of the stock market or bonds and go to cash and wait. This is a surefire way to lose money in the market. My advice to my clients is to stay the course. Building a portfolio is similar to having a home. Your home protects you from inclement weather and keeps you sheltered. When it threatens a storm outside, you don’t run outside and knock your house down! The same concept applies here. If we see economic storms on the horizon, we remember that we built our investments to protect us for the long-term, and trust in the safety of the overall strategy!
If you are concerned about whether your investments are properly set up to meet your goals regardless of what the markets look like, want to talk to me about the markets to get some clarity, or just have questions about finance in general, please reach out to me! I’m available to answer questions about the markets, review financial plans, and answer any tax or estate questions you may have!
About the Author:
I work as a Financial Consultant with my partners Bob Montavon and Tom Schwab for Resolute Wealth Management, LLC. After spending several successful years in business management working with clients in the retail and construction equipment industries, I transitioned into financial services to help make a greater impact on my client’s lives. I work with clients from many different backgrounds, incomes, and situations. By helping clients identify where they are and where they want to go, I serve as a fiduciary and trusted advisor to help them dodge roadblocks, adjust to different situations, and reach those goals. I graduated from Wright State University in 2018 with a degree in Investment Finance, and completed my MBA work at The Ohio State University. I currently hold the Chartered Financial Analyst (CFA®) designation, and serve as membership chair on the Board of Directors of the Dayton CFA Society. In addition, I am a member of the Centerville Noon Optimists of Centerville, OH, a volunteer and social organization working to promote opportunities for local youths in the Centerville/Washington Township communities.
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