Don’t Fear This Signal… Yet

Few headlines irk me more than ones like these:

• “What’s a Flattening Yield Curve and Why It Should Scare You”

• “Flattening Yield Curve Raises Warning Flag”

• “Wall Street Roiled By FOMC, Flatter Yield Curve”

The three headline examples above are warnings about an important indicator called the “yield curve.”

These types of headlines irk me because they’re clickbait… they’re fearmongering at its worst. If you follow the advice they purport to give… you’d end up selling at the wrong time.

At the Daily, we want you to know what’s really going on in the markets.

We don’t want you to panic, sell your stocks too early, and miss out on more money-making opportunities still ahead of us.

That’s why today, I’ll tell you what the yield curve is… and why it’s so important for investors. I’ll also tell you how the mainstream press has bastardized this important indicator.

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The Yield Curve Explained

The yield curve is a graph that plots the interest rate of government bonds based on length of maturity.

Yield curves generally slope upwards—like the one below.

In a healthy economy, bonds that take longer to mature pay a higher yield… That’s because bondholders want to be compensated for the extra risk of holding their bonds long-term.

For example, the current U.S. three-month bond yields about 2%, whereas the current 30-year bond yields 3.3%. Since the 30-year bond has a longer maturity date, the interest rate is higher.

Sometimes, the yield curve doesn’t slope upwards. It will flatten, or even slope downward.

Wall Street calls this an “inverted” yield. Inverted yield curves are an important market indicator. They have preceded the past five recessions.

When the Fed “tightens” (raises) interest rates, short-term rates sometimes rise higher than long-term rates. This puts some banks in a tough spot.

Banks often borrow money in short-term markets and then lend that money long-term. When the yield curve inverts, it costs banks more to borrow money to loan than they receive in interest payments.

That’s a money-losing strategy. So banks curb their lending. Without credit, the economy—and stock market—contracts.

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There’s no disputing that an inverted yield curve is an ominous sign. It works (at least in the United States), but it’s not as timely an indicator as the financial press would have you believe.

If you follow their fear-inducing headlines and sell right away, you could put your portfolio—and retirement—at risk.

We Still Have Months to Prepare

What most articles about the yield curve won’t tell you is that the market will continue to rise even after the yield curve starts sloping downward.

Look at the chart below… The black line shows the S&P 500. The blue line shows the difference between 10-year and the two-year yields.

When the blue line dips below zero, that means the yield curve has inverted. As you can see below, the yield has not inverted yet.

But even if it had, we’d still have plenty of time to prepare…

The next two charts show the last two times the yield curve inverted. Both times, investors still had time to ride the market higher.

In January 2006, the curve inverted but the S&P 500 didn’t peak for another 20 months—in October 2007. In February 2000, the yield curve inverted seven months
before the stock market completed a double top.

You’ll also notice that this spread stayed low for three years (and had a false signal) before the real inversion happened.

A similar pattern occurred in 1989, 1980, and 1978.

As you can see, there is plenty of time to prepare yourself after the yield curve inverts. So there’s no need to worry and sell right away.

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Basically, the mainstream media are warning you about… a potential warning signal.

That makes no sense.

I’m not going to change my investment strategy because of a warning about a warning. Especially when the danger the actual signal warns about takes an average of 18 months to play out.

We’ll have plenty of time to adjust our portfolios after an inversion happens. We’ll let you know when the time is right.

Until then, ignore the fearmongers and keep holding your stocks.

A few good places to wait out the warning signals are the small-cap iShares Russell 2000 ETF (IWM), SPDR S&P Biotech ETF (XBI), and the VanEck Vectors Semiconductor ETF (SMH).

Regards,

Nick Rokke, CFA
Analyst, The Palm Beach Daily

P.S. The yield curve is flattening because the Federal Reserve is raising short-term interest rates. Rising interest rates will hurt certain companies and investments—but not all. Palm Beach Letter subscribers should check out editor Teeka Tiwari’s red flag list of 277 investments to avoid as rates rise right here. If you’re not a PBL subscriber, you can learn more about the coming danger right here…

Last week, Palm Beach Confidential editor Teeka Tiwari asked Daily readers how they respond to misinformation about cryptocurrencies. And you responded…

From Maralissa T.: I have joined several crypto groups in Silicon Valley. I’m taking the time to understand the innovative genius behind cryptos and their healthy applications for the future.

Those applications threaten the foundation of many different institutions. And some of them fear that—at last—something that works for the people, by the people, and of the people will replace their undercover swindling games. So they are lashing out in an attempt to try to keep their stronghold on others.

It may be a bloody battle while we remove the blindfolds of the masses, so they can see and prevail. But the momentum is with the new technology, not the old banks.

From Joseph O.: I choose to ignore the outside noise about the collapse of cryptos. I see two things going on here with this noise… two separate, but well-timed and coordinated attacks.

One prong is bad-mouthing of cryptos by banks to protect their already entrenched positions. The second is to delay the price spike long enough so Wall Street can put itself in a more advantageous position to invest in cryptocurrencies and blockchain technology… so that they can control it just like they do the banks and fiat money.

The control factor really frightens me about the banks and big-monied investors.

I think Teeka should do a comprehensive address about how Big Money is driving people out of cryptos.

From John A.: I agree with most of what Teeka says about cryptos. I have invested a reasonable amount into his recommendations and I plan on holding them for a least a year before evaluating my decision.
The reason I write today is to say that I do think the Bank for International Settlements (BIS) is right to be critical of what Teeka calls, “The pimple on the backside of global economics” using 25% of the energy that the banking system uses.

Readers also responded to our June 21 interview with Emmy Award-winning journalist John Stossel, who says college is a rip-off for many people…

From Peter A.: Regarding Nick’s interview with John Stossel, a Pew Research Center poll found Americans are split on the main purpose of college. 47% say the purpose of college is to teach work-related skills… And 39% say it’s to help a student grow personally and intellectually (12% say college should do both). 

Not surprisingly, college officials say that skills valued by employers and critical for employment are the same as those needed for civic engagement. Critical thinking, problem solving, working in diverse teams, ethical reasoning, communicating—these make both good employees and good citizens.  

As a business owner, I can’t always tell when a prospective employee is curious enough to do things right…  They are not always the one with a degree. But what else do I have to go on?

Want to get in on the debate? Send us your comments right here…

Silicon Valley insider Jeff Brown has spent the past 27 years working at the forefront of new technology. And right now, he’s investing more money in ICOs than any other investment in his life.

He’s been doing so for the past four years. He’s never been “scammed.” And so far, he hasn’t lost a penny. Why? Because he knows something about the explosive ICO market most people don’t…