The Yield Curve Inverted: Is a Recession Next?
The leading indicator for a recession is here
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One of the things that I love about our community newsletter is that it’s made up of people who are complete newbie beginners to finance and all the way to people who run funds on wall street. As most of you know, I take a lot of pride in making things incredibly simple. However, a fair warning that this subject is a bit more complex for the beginner.
The four worst words in all of finance is: “This time is different.” I heard a real estate agent say this the other day about the housing market, and I heard a fund manager say this on cnbc about the yield curve.
I am a firm believer that people who “try and time” depressions or recessions are playing with snake oil. However, we can use indicators of the overall market that will give us “hints” about the future.
Remember: History doesn’t repeat, but it does rhyme.
In the past, we have talked about how the fed has failed multiple t
The treasury market is flashing a warning sign to the markets, but we are hearing big pushback from wall street that “this time is different.”
The Yield Curve
The yield curve inverted last week. Historically speaking this is one of the leading indicators that a recession is upon us.
When you look at a yield curve, you are specifically looking at the interest rate between a 2 year bond and a 10 year bond and you subtract one from the other.
In a healthy economy, you typically want interest rates to rise slowly over a long period of time. The reason that you want this is because you are guessing that the economy will be healthy, there will be a nominal amount of inflation, and as a result of that you need to get paid more for the future than today.
In theory, if you want me to take on the risk of buying a 10 year bond, you need to be paid more than if you take on the risk of a 2 year bond. The chart should be going up and to the right.
*read the bold sentence again, very important in understanding this concept*
When the yield curve inverts this means that you get paid less for owning the 10 year bond than you do for owning the 2 year bond. The complete opposite of what we want.
When this happens, people believe that the government will cut interest rates dramatically to stimulate the economy. This will allow money to get back into the system. However, if we keep interest rates low, inflation will keep soaring.
What does this mean?
Historically speaking the best way to fight a recession is by cutting taxes, increase government spending, and lowering interest rates. However, we no longer have these bullets in our gun. :/
The economy is 110% going into slow down and whether or not this goes into a recession is still to be determined. I do believe that there is a very good chance of a recession happening.
The economy was due for a slow down to begin with because of raising interest rates to slow inflation, the supply chain disruption, and we have completely removed 144 million Russians from the global economy which will hurt our economy in the coming months.
A recession by definition means negative economic GDP growth for two quarters in a row. The average time that a recession lasts is normally 18 months.
In my opinion, there is a good chance that we have stagflation which means high inflation along with a slowing economy.
What should you do?
A recession is an incredible buying opportunity for the smart investor.
If a recession happens, this is a phenomenal time to buy great companies on a major discount.
You have to remember that when everyone was partying in 2020-2021, Warren Buffett was sitting back and adding massive cash positions.
Warren knows that eventually the party will end and people will have major hangovers. Remember, history doesn’t repeat, but it does rhyme.
Warren has seen this multiple times in his 92 year investing career.
We are already seeing a dispersion underneath the hood of the stock market. What this means is the bad companies have gotten crushed while the good companies have gotten hit hard but not crushed. When the market rallies, the good companies are usually the only ones to rally.
We have Q1 earnings coming up, and I believe that we will see a massive diversion between the good companies and the bad companies.
We will have a handful of businesses that show strength. They know what they are doing, they understand how they will perform, and they will focus on growing during these tough times. These companies will get rewarded.
Everyone else will be exposed for their flawed business model. Any business that uses the economic excuses to explain their poor performance will get whacked.
Recessions bring great opportunities to find great companies on a major discount.
I hope you have a great rest of the week! Talk soon!
Stay Hungry, Stay Long,