Hi I'm Jimmy in this video we're
going back to the inverted yield
curve. We're looking at what the
inverted yield curve has done lately
and what it can tell us about the
economy.
So a few months back the inverted
yield curve was dominating the
headlines.
Yet most recently it seems
that the headlines have been
dominated by the lowering of
interest rates by the Federal
Reserve or the possibility of
lowering interest rates by the
Federal Reserve.
To illustrate this is a chart of the
S&P 500 since the start of last
month. And as we could see it was
trending lower on news about trade
wars mostly and then
the start of this month.
Well it started heading higher
once it came out that there was a
possibility that the Federal Reserve
might lower interest rates.
Then the market reacted by driving
things higher.
Now on one hand that's actually
somewhat logical since lower
interest rates does
lead to higher stock valuations
and in theory high stock valuations
should lead to a higher stock
market. We did a video on this exact
topic after Warren Buffett came
out and said that if interest rates
stay low well then the stock market
may be cheap.
You can see a link in the description
below to that video.
But generally the Federal
Reserve would only lower interest
rates if they were trying to spur
the economy.
So them coming on now and saying
that they may cut interest rates
would imply at least to me that they
may be losing confidence in the
economy's ability to keep pushing
forward which is
sort of the opposite of what I
assumed that they felt back when
they were raising interest rates.
Now I'm sure that there are some
people saying how bad things are for
the US economy or we're already in a
recession or we're about to fall off
a cliff or whatever it might be.
And I suppose we can all define
a recession how if we like but
the technical definition that the
Federal Reserve uses for the
definition of a recession is
two consecutive quarters of negative
growth in GDP.
So this chart here of GDP
is we could see growth has been at
least okay up until this point.
But clearly the Fed is worried about
something if they're already talking
about lowering interest rates so
soon after they were just raising
them. So let's look at what happened
and then we can see if there if we
can come up with something for the
future of the economy.
So recently I did a video on
the inverted yield curve looked at
the basics of it and then we
analyzed some historical
recessions and tried to look at what
the inverted yield curve looked like
before those recessions.
If you're curious you could find a
link to the to that video in the
description below.
But ultimately to summarize that
video what makes the inverted yield
curve important is its ability to
predict recessions.
And as I pointed out in the last
video all recent recessions
have been preceded by an inverted
yield curve but not
all inverted yield curves
have led to recessions.
So basically that means that
sometimes we get an inverted yield
curve and we don't get a recession
but other other, but we've never had
a recession that wasn't preceded
by an inverted yield curve.
So what exactly is in inverted
yield curve.
Well basically it's when
short term interest rates are
higher than long term interest
rates. And if we think about it it
actually makes sense that this would
be a problem specifically for
banks.
So banks generally borrow money
at short term interest rates and
then they loan that money out at
long term interest rates.
Well if they were borrowing at a
short term rate that was higher than
they could loan it at.
Well that would lead to an
unprofitable unprofitable
transaction unprofitable
transactions are likely to lead to
the bank not lending money.
Banks don't lend money.
Generally that spells trouble for an
economy. So in the last inverted
yield curve video that I did that
one was at the end of March of this
year. Well this is what the yield
curve looks like.
And as we could see it is inverted.
We know it's inverted because the
three month Treasury bills
are actually higher than the
10 year Treasury bills.
And at that time was only two basis
points higher but negative
nonetheless.
We say it's negative because if you
take the 10 year Treasury bill and
you subtract the three month
Treasury bill you'll end up with a
negative number.
If it is inverted in a positive
number it's and if it's a normal
yield curve. So this chart here
this chart starts at the beginning
of 2019 and it's showing
us the spread between 10
year treasuries and three month
Treasuries.
So basically if you get to this peak
right here well this peak that
32 is 32 basis
points higher.
So what that means is that right now
that at that peak the 10 year
Treasury is trading 32 basis points
more than the three month Treasury
is paying.
But then the spread begins to fall
and back on March 22nd.
The yield curve inverted.
And we know this because that
number is a negative number.
And a few days later right here
on the twenty seventh.
Well that's when I published the
yield curve video that I keep
referring to.
Basically I was talking about the
fact that this could be a problem
for the economy because it's
negative and it's been negative for
at least a few days at that point.
Now one key point that I brought out
in that video was that although
there's not a hard and fast rule
regarding this generally it's
accepted that the yield curve
should stay inverted for at least
10 days before it's considered
a very strong or powerful
sign and I bring this out
because just a few days later
the yield curve started to improve
and it no longer was inverted.
Just two days after I'd done the
video and by the time we got into
early April.
Well the excitement about the yield
curve had mostly died down and less
and less people were talking about.
But now let's switch over to what
the actual yield curve looked like
at the beginning of May from this
year. So as we could see
the yield curve was mostly normal.
Sure. The two in the five year notes
are a bit lower but economists
tend to focus on the spread either
between three month and 10
year or two year and 10
year. Now technically the two
year and 10 years actually the
stronger of the two but
the three month tenure is
well-documented as well.
And then in the middle of last month
while the yield curve once again
inverted.
And now we're gonna begin our day
count and interestingly it
only stayed there for one day this
time but a week or so goes
by. And once again it
inverts except this time
it stays inverted and our day
count continues to rise.
So now as you can see
we've now passed that loosely
defined 10 day marker
and it's continued to push higher up
until today.
OK so now what.
Well if you happen to see the more
in-depth video that we did on the
inverted yield curve.
Well you may remember that one of
the issues with the inverted yield
curve is timing.
So sometimes when the yield curve
inverts as it is right now.
Well that may lead
to a recession in the next
few months of the next few quarters
or perhaps it leads to a recession
in the next handful of quarters
for the next couple of years.
Timing is an issue.
That's one of the problems with the
yield curve.
Now in my mind this gives me at
least some idea of what the Federal
Reserve might have been thinking
about when they talk about when they
float out the idea of lowering
interest rates.
So the Federal Reserve when
they lower interest rates they don't
directly impact any one of these
rates. Essentially what they can do
is they can they reduce super
short term rates overnight rates
and that in theory should have a
bigger impact on three month rates.
So if they see the yield curve
inverted like this and I'm sure that
they do well it would make sense for
them to try to drag down the three
month rates and hopefully the market
plays along and they could try to
flip this whole thing to be more
positive and then perhaps they're
able to incite enough growth in the
economy to keep things moving
forward. And perhaps that staves
off a recession at least in the
short run.
Now this could possibly explain why
we might get an inverted yield curve
and not a recession afterwards.
Clearly though the inverted yield
curve isn't the only thing that
they're looking at.
And the only thing we should
consider. So what should we do as
investors.
Well for me this is a big
deal and this is the strongest
sign I've seen of
the possibility of recession
coming around the corner.
Sure it's felt like a recession
should come since we've had such
an amazing bull run for
so long. I think we just passed a 10
year mark which ties it for the
second longest one in history.
But sure there's been signs
before this but none of them is
clear and distinct is this for me.
Now I still don't believe that
sitting on the sidelines makes a lot
of sense when it comes to investing
but full disclosure.
That's really just the way I think
about things.
It's how I'm sort of built when it
comes to investing.
It's my attitude towards it in
general which is mostly tied
to my personal level of risk
tolerance which frankly
is quite high.
I don't mind putting money to work
today and having the stock
market tank tomorrow
and then I can watch it recover
I can gradually get it to recover in
the years that followed but now
that's not to say that I think it's
smart to act the
same no matter what we think the
economy is doing.
Personally I think it's time to be
defensive right now and I think it
makes sense to shift our portfolios
into more defensive holdings out
of more speculative holdings
assuming we have the ability
or the willingness to sell some
names and buy some others.
How defensive is really the
question.
That being said I actually did a
video at the beginning of March
called Should I invest now or
wait for a market crash.
And in that video I walked through
a few different leading economic
indicators the inverted yield curve
was one of them at the time.
Well I got a lot of requests
to do that more continuously
on at least on a quarterly basis.
And right now we happen to be at the
quarter mark.
So I expect to be publishing that
over the next week or two and I
think that should give us a better
idea as to let's
say a broader picture of the overall
economy on top of just the inverted
yield curve.
For now I think it makes sense to
stay defensive but
keep watching this because this
could end up being a big deal.
And then if we can look at the other
economic indicators perhaps we can
get a better idea that way we're not
blindsided if something big
happens and if we've been watching
it I think we'll do a better job of
forecasting what could possibly
come. So my question for you is what
do you think is going to happen to
the stock market over the next year.
One year from today we're all a bit
up down or sideways.
Let me know what you think of the
comments below.
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Thank you for stick with me all the
way to the end of the video and I'll
see in the next video.
Thanks.