There are some Investment Advisors who are always optimists (“Bulls”) which may cause their clients to lose sleep in a wildly volatile market. Some may be regularly pessimistic (“Bears”) resulting in a possible lower eventual income. I like to think of our Advisors as realistic in our financial planning and investment advice. From the very beginning, as Fiduciaries, we have made the attempt to put your “Best Interest” first by taking many of your life-factors into consideration.
While there is no crystal ball, there is historical information that allows us to prepare for what could happen. The following blog post by one of our trusted service providers does a good job of detailing one way to look at the current economy and investment markets.
I am positive and do believe the market will improve and move out of this down cycle. It has always happened before. But it’s information like this that makes me take another look before we decide to jump on the “all’s clear” bandwagon.
This post is included on our website with permission from the author. As a disclosure, our broker/dealer, United Planners, has no affiliation with Scott Colyer of Advisors Asset Management (AAM). Any comments or opinions are those of the author, not United Planners.
But I think it’s very interesting.
AAM Viewpoints — Fun Facts Surrounding the Yield Curve and Recessions
By Scott Colyer, CEO, Advisor Asset Management
I have been lucky enough to have participated in the financial markets for nearly 40 years. During that time, I have witnessed interest rates range from double digits to negative. I have been through many recessions as well as a couple of wars. I have seen the financial system crash at least two times. In all those instances I learned firsthand that the bond market gets it right long before the equity markets do. In all those instances the U.S. Treasury yield curve served as an early warning signal. A type of “canary in the coalmine,” if you will. However, I have never seen a yield curve so BOLD in its warning of a coming economic downturn. The severity of the current inversion is so pronounced and massive that I cannot see any other outcome than a very difficult economic recession that is likely now upon us.
When I look at the equity markets, I see an opposite story. I see pundits willing to dismiss the early warning signs noting it is “different this time.” I see the five largest technology stocks out of the S&P 500 accounting for nearly a quarter of the 500-stock index’s market cap. I see valuations of those stocks surpassing 30x earnings with very narrow breadth. I see crypto rising 56.3% year to date, which is the epitome of speculative activity. I see the “experts” preaching that the bear market has died at the same time as M2 (M2 is a measure of the U.S. money stock that includes M1 (currency and coins held by the non-bank public, checkable deposits, and travelers' checks) plus savings deposits (including money market deposit accounts), small time deposits under $100,000, and shares in retail money market mutual funds.) is being drained out of the markets at the fastest pace ever. Finally, I see what appears to be a major collapse in prices of regional banks. When banks are damaged, they don’t lend. If they don’t lend, then capital becomes unavailable to businesses and individuals. They become the transmission mechanism of the Fed’s desire to starve demand for goods and services.
What does the best evidence tell us about the future of the economy? Is the shape of the yield curve still the best indicator of the health of the economy? Could it be different this time? Courtesy of Bank of America, here are some “fun facts” about the current ultra inversion of the U.S. Treasury yield curve:
- The yield curve has been inverted for over six months. The last time that happened was in 1981.
- In the past 100 years the current 170bps (basis points) of inversion in the 3-month vs 10-year (3m10yr) yield curve has been exceeded on just 125 days. See chart below:
Source: Bank of America Global Research | Past performance is not indicative of future results.
- Ten recessions in the U.S. since 1957; each was preceded by tight monetary policy and inversion of the 3m10yr and/or 2yr10yr curve.
- On average, a U.S. recession has started six months after inversion of the 3m10yr curve and 11 months after the 2yr10yr curve.
- In this cycle, the 3m10yr inverted in November 2022, so using the timeline above, the recession should have begun in April 2023 (last month). The 2yr10yr inverted in July 2022, which projects a recession will begin in May 2023 (this month).
- Inverted yield curves signal recession, but once the recession begins the yield curve immediately steepens as markets discount the Fed’s policy response to a recession. The 2yr10yr peaked inversion at -108bps in April.
- The 2yr10yr curve has STEEPENED 60bps since March 8 (Silicon Valley Bank collapse) but remains around 54bp inverted. In contrast the 3mo10yr curve has barely steepened. If the 3m10yr curve steepens in the next few weeks that would corroborate a recession now.
- The speed of the yield curve steepening was quick in disinflationary cycles (1990s–2020). It was much slower in inflationary cycles (1970s–1980s). If a recession is imminent, the ongoing inversion of the 2yr10yr (rather than positively sloped) strongly suggests this is an inflationary cycle and fits with “sell the last rate hike.”
Other Recession Now Signals
- Oil is struggling as demand is waning. OPEC (Organization of the Petroleum Exporting Countries) is cutting supply to balance the market.
- Manufacturing is slowing — ISM (Institute for Supply Management) index is at 46 (contraction level).
- Housing prices are falling across many developed markets.
- Credit is becoming scarce as liquidity dries up. Lending standards to small businesses at tightest since December 2012. Banking crises will likely constrict it more. The growth in M2 money supply (-4.1%) is the greatest amount negative since 1933.
- Regional banks are failing. Depositors are abandoning these banks in favor of money markets which have ballooned to a record $5.3 trillion.
- U.S. government has a debt ceiling problem which could result in a 2011 moment when U.S. debt was downgraded by S&P. The cost to insure U.S. government debt against default (Collateral Default Swaps) for the next year is at RECORD highs. The market perceives a huge amount of risk and volatility.
We realize that nothing is certain in the financial world. I can say, however, that when the canary is near death, we seek shelter and protection. Add to that a “U.S. debt ceiling debate,” the banking system wobble and the narrowness in equity leadership, we believe that gains will be hard to come by unless you are a short seller until deep into the recession.
- Bond markets begin to heal generally before equity markets. The Fed Fund futures are indicating that the Fed’s first cut of rates will likely come in the 3rd quarter of 2023. People hope for a pause, then a cut.
- Financial conditions will have to slow precipitously to cause the Fed to cut rates.
- Be careful what you ask for. Pivot equals pain!
- With the first rate HIKE, the equity markets lose on average 23.5% over the next 195 trading days before bottoming.
Source: Strategas | Past performance is not indicative of future results.
The moral to this story is that the significant weight of the evidence — which has been a reliable indication of what is to come — points squarely at recession. Credit and equities get punished in recessions. We don’t suggest market timing, but we believe you should consider tilting your asset allocation defensive with high quality companies that have defensible profit margins.
CRN: 2023-0502-10861 R
Scott Colyer, Chief Executive Officer, Advisor Asset Management
With over 35 years of industry experience, Scott Colyer has become a highly-respected fixed income strategist and investment counselor.
Taking a truly strategic approach to portfolio management, Scott focuses on macro and micro economic trends to navigate complex market cycles. His insights are frequently featured on several leading financial media outlets, including The Wall Street Journal and CNN Money. He is the CEO of AAM, a position he has held since 1998. He also served as the Chief Investment Officer for 23 years.
This commentary is provided for information purposes only and does not pertain to any security product or service and is not an offer or solicitation of an offer to buy or sell any product or service. Unless otherwise stated, all information and opinion contained in this publication were produced by Advisors Asset Management, Inc (“AAM”) and other sources believed by AAM to be accurate and reliable. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice.
All AAM employees, including research associates, receive compensation that is based in part upon the overall performance of the firm. AAM may make a market in or have other financial interests in any given security with which this analysis suggests may be benefited from its conclusions. Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Past performance does not guarantee future performance.
Interests in any given security with which this analysis suggests may be benefited from its conclusions. Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Past performance does not guarantee future performance.
All content on this Site is presented only as of the date published or indicated, and may be superseded by subsequent market events or for other reasons. In addition, you are responsible for setting the cache settings on your browser to ensure you are receiving the most recent data.
The chart and/or graph does not reflect past or current recommendations made by Advisors Asset Management, Inc. (AAM), and should be considered an academic treatment of empirical data. It is designed for educational purposes only and should not be used to predict security prices or market levels. Any suggestion of cause and effect or of the predictability of economic or investment cycles is unintentional. This report should only be considered as a tool in any broker, dealer, or advisor’s investment decision matrix. Investors should consult their financial advisor when applying the assumptions of the chart or graph.
Twitter is an online microblogging tool, whereby users can post interactive content, (up to 140 characters in length) and web links. Individuals using Twitter can subscribe to AAMlive’s Twitter account and “follow” AAM’s posts. AAM utilizes this online communication tool to maintain an “electronic library” that may contain research reports, news, quotes, announcements, charts and other media that can be accessed through a public link.
Investors should consult their financial professional before making an investment decision. Content is for informational purposes only and is not an offer to purchase or sell any security. Any forward-looking statement is an opinion and should not be considered a forecast. Past performance does not guarantee future results. AAM may make a market or have financial interests in any security or sector discussed.
Twitter is a public forum. Do not post any personal or confidential information. AAM is not affiliated with Twitter and has no responsibility for its operations and/or services.
Third-Party Comments on AAM Blogs
Third-party posts do not reflect the views of AAM and have not been reviewed for completeness or accuracy. Any inappropriate or offensive comments should be reported to [email protected].