The Impending Recession & Inverted Yield Curve

Jul 21, 2019 2:49:00 PM / by Jonathan Blau


First, some historical facts about recessions:

  1. There have been 11 since WWII, occurring on average, one year in seven and, on average, they last 11 months;

  2. An inverted yield curve refers to when the yield on the two year treasury is higher than on the 10 year treasury. The economy has experienced a recession, on average, 17 months after an inversion occurs;

  3. The inversion that occurred on August 14, 2019, which resulted in a one day drop of 800 points on the Dow Jones Average, lasted about 5 minutes while the 2 year yielded 1.628% and the 10 year yielded 1.619% — a difference of 1 basis point (1/100 of 1%).

  4. There hasn’t been a recession since 2008-2009 and the inversion in the yield curve said to have predicted the 2008-2009 recession occurred about two years prior, in December 2005;

  5. On average, during the post war recessions, GDP slowed to negative 1.8% and the return for the S & P 500 was positive 3%;

In sum, the financial media catastrophized for close to a week about this. Given that recessions happen about every 7 years and we haven’t had one in almost 10, we don’t need any particular media prognostications to know we should expect one! Of course, we still can’t time it, nor does it matter.

What has been the default response of investors to this “news?” According to the Investment Company Institute, investors dumped $18 billion into money market funds for the week ended August 16, pushing total money market assets to a near 10 year record of about $3.4 trillion!

So, here we sit, living through the most powerful bull market in a generation and the presenting sentiment and reaction, respectively, of the investor is still increasing fear and capitulation. The most recent American Association of Individual Investors (AAII) sentiment survey shows that the percentage of investors expecting stocks to rise over the next six months is at 23% (near records lows) while those expecting a market fall stood at 45% (1.5X the long term bearish sentiment average of 30%). Similarly, according to Bernstein research, the end of the second quarter saw stock outflows and bond inflows diverge at the most extreme pace in 15 years. Equity outflows ballooned to $155 billion while bond inflows surged to $182 billion. When such divergences happened in the past, equities soared between 10% and 22% the following year. Those parked in money market funds having no plan to follow and no behavioral investment coach to check their poor investor behavior, will likely miss all of it and will have continued to jeopardize their wealth and retirement.

Most of the year’s equity outflows occurred in response to a less-than-average 7% downward monthly blip ending in early June when investors responded in abject terror to new Trump tariff tweets. A $24 trillion basket of 505 companies (aka S & P 500) cannot be inherently unstable; quite the contrary. Presidents and congresses come and go. Our politics may seem as viciously partisan as it has ever been – until you look at how bitterly divided we were two years prior to Pearl Harbor (1940 Revolution) and at the election of 1800!

The only thing new in the world is the history you do not know.

Harry Truman


Profit seeking companies – unlike western governments – will react rationally to conditions as they find them; the best will continue to grow and prosper. Economic life will go on. It is not, and never will be, reducible to a tweet storm. And, we will never see this again! -This being an equity market that, with compounded dividends, is close to quintupling its lows of 10 years past — which is still generating ever-increasing waves of investor capitulation with every minor setback and every episode of financial media catastrophism.

In late December 2018, we encouraged investors to seize on a rare opportunity to invest at or near record high levels of investor pessimism. As pessimism has actually increased since that writing, we encourage the same at this writing and we are as convinced as ever that this cyclical bull may still be in its relatively early stages (if not at the half-way point). We will certainly experience some cyclical bear markets on the way up as we did with last year’s 19.8 percent decline from September 20 through December 24 (while down 20% is an official bear, 19.8 versus 20 is a distinction without a difference). When investor enthusiasm to own equities is peaking during the next dotcom-type bubble, we will know the bull is on its last legs. Until then, we continue to march!

Investors who want to succeed must stop reacting/adjusting their portfolios in response to the media and to current events. They must stick to a plan and remember that macroeconomics is not a financial planning function – nor are current events. Our experience has shown that almost all successful investors are goal-focused and planning-driven, while almost all failed investors are market-focused and performance-driven. Successful investors are continuously acting on their plan, while failed investors are continually reacting to the markets, current events and media catastrophism. When faced with your next fear relating to current events, ask yourself: “How much do I think this will matter in the 20th year of my retirement?” Because that, together with the 10 years on either side of that, is the focal point of your plan.

Here is some real GOOD news that you won’t get from the financial media:

  1. In the first quarter of this year, household net worth soared 4.5%, its biggest quarterly rise in 14 years – reaching $108 trillion ( up from its 2007 pre-recession peak of $68 trillion);

  2. According to JP Morgan, household debt payments as a percent of disposable income dropped to 9.9% — a 40 year low!;

  3. Total wages rose 4.6% in the 12 months ending in May;

  4. Unemployment stands at 3.7%. In May, the median duration of unemployment fell to 9.1 weeks, while the percentage of unemployed who voluntarily quit rose to 13.5%. These two metrics are indicative of a tightening labor market, rather than an economy that is stalling out.

    Number 3 and 4 are an unalloyed good in an economy 68% propelled by the consumer.

  5. BREAKING NEWS AS I WRITE….two large consumer driven companies – Target and Lowes — reported earnings this morning and they shot all the lights out! Both are up 20% and 10%, respectively today setting fresh all-time highs! Confirmation that the consumer – and our economy — is alive and kicking!!

In closing, remember Sir John Templeton’s timeless summary of bull markets:

They are born on pessimism, they grow on skepticism, they mature on optimism and they die on euphoria. I have said before and I now say again, we are still stuck somewhere between pessimism and skepticism and eons away from euphoria and likely from the end of this bull market.

We hope you all had a wonderful summer and we look forward to seeing you in the fall!

Tags: Latest Insights

Written by Jonathan Blau