Just in the last few days, there’s been a lot of talk in the financial world about yield curve “inversion.” Maybe you’re familiar with the term, maybe you’re not. Either way, we think it’s worth talking about, because it plays into the way we allocate our funds in the market.
Q: What’s a “yield curve inversion?”
A: It’s when a longer-term interest rate (like the 10-year Treasury note) actually goes lower than a nearer-term interest rate (like the 2-year Treasury note).
Q: Why do we care about it?
A: Because it’s the best single gauge of recessionary pressure out there.
Q: Why is it a good gauge?
A: Because it means that people generally don’t want to borrow money for longer timeframes.
Q: Why don’t they want to borrow?
A: Because they don’t expect to be able to make more profit than they’ll have to pay in interest.
Make sense? Basically, a “yield curve inversion” just means that, broadly speaking, the credit market is telling us that there won’t be economic growth, because people don’t expect to be able to make much business profit in the coming years.
Of course, any economist could tell you something like this. But “any economist” isn’t a very useful guy to have around. What’s much more valuable is taking this indicator and making it practical by comparing the yield curve to stock market returns throughout history. And when we do that, we get this:
This is Recession Risk over time. When Recession Risk is at zero, that’s a great time to be in stocks. When it’s at 40%, that’s not such a great time to be in stocks. When it’s somewhere in the middle — well, it’s somewhere in the middle.
The highest the Recession Risk indicator has ever gotten is around 40%, which, translated, means that “there’s a 40% chance that the market will stay flat or go down from here.”
That may not sound like a lot, but in the world of investing, a “40% chance” that stocks are going to go down is a REALLY BIG DEAL. Which is why we’re going to KEEP YELLING about this Recession Risk indicator — because it’s KIND OF IMPORTANT.
Right now, “there’s a 17.28% chance that the market will stay flat or go down from here.”
Recession Risk is one of the factors that we plug into the “Your Allocation” computation, so if you’re already following the system, fear not, you’re already doing everything right.
If you’re not already following the system, then we hope that you’ve got your own way to accurately weigh the risks presented by the stock market.
Because this is KIND OF IMPORTANT.