No one can say for sure where the market is headed, but Spinnaker Investment Group can help provide you with sound advice and guidance to help with varying investment goals in all types of investment climates. When in the midst of an extended economic expansion, it’s easy to wonder if a downturn will ever occur, but economic cycles have always transitioned from growth to recession and back again. And in fact, one specific economic indicator, the inverted yield curve has preceded every recession since 1956. The salient issues are whether the formation of an inverted yield curve is an absolute predictor of a recession and if so, what that means for your investment strategy.
The elements of an inverted yield curve
A yield curve is a graph that depicts the relationship between the short term and long term interest rates for U.S. Treasury securities. Yield is on the Y-axis and maturity is shown on the X-axis. When the economy is in an upward cycle, short term interest rates are lower than long term, so the yield curve appears as an upward slope. If the difference between short and long term rates lessens, the curve flattens, and if short term rates exceed long term rates the curve inverts.
Why long term rates fall
Some analysts prefer to compare the 3-month T-note with the 10-year Treasury note and others use different maturity terms, but the message is essentially the same. When the curve flattens and ultimately inverts, confidence in the long term economic outlook is poor. With a vibrant economy, long term rates need to be higher to compensate the investor for the risk of locking up funds for that period. If investors fear a recession, long term notes are acceptable primarily as a capital preservation means, the demand is greater and the price increases, but the yield drops. Often, it’s the concerns of the investors that become the tipping point for turning a flattened yield curve into an inverted one and for the recession that may follow.
History serves as a lesson for what may be today’s reality, but interceding factors can alter that path. For example, some commentators point to the continuing strong affinity for foreign purchases of U.S. backed securities as creating more of a supply and demand factor in the long term rates rather than strict reliance on a cooling of the economy. Additionally, the Federal Reserve Board can act or choose not to depending on its perception of what’s in the best interests for the economy or on other factors.
The individual investor
Your strategy should not be altered by short term market movements. Of course, if you are looking for a short term investment, select the one that provides the highest yield, but your overall strategy should be based on long term thinking and long term convictions. Spinnaker Investment Group can be of assistance in developing the investment strategy that best suits your individual needs.
The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities mentioned. The information contained herein, while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.