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Key recession indicator is flashing red. Unlike the stock market, which is both backward- and forward-looking, the bond market is myopically forward-looking. W

by apo 7y ago

Key recession indicator is flashing red. Unlike the stock market, which is both backward- and forward-looking, the bond market is myopically forward-looking. When the yield between the 10-year and 2-year US treasury inverts, a recession is months away. This chart, showing the difference between the yield (or spread), shows recessions in grey: https://journal.firsttuesday.us/using-the-yield-spread-to-forecast-recessions-and-recoveries/2933/ https://journal.firsttuesday.us/using-the-yield-spread-to-fo... Notice how even getting close to zero spread can sometimes be followed by a recession. But a negative spread always does. Point to consider is the effect of Quantitative Easing (QE). Here, the Fed buys long-term treasuries such as 10-years. This makes long-term rates appear lower than they would otherwise be. The Fed only slightly unwound this policy, meaning it still holds most of the long-term bonds it bought to fix the 2008/2009 crisis. The net effect is that the Fed could be triggering an early recession warning here. Regardless, combining this leading indicator with others such as transportation weakness, manufacturing slowdowns, and other economies tipping into recession (despite the loosest central bank policies in modern memory) leads to only one conclusion. Prepare for the inevitable recession. It's not different this time. Edit: one way to play this as an investor is to buy long-term treasuries. The idea being that as interest rates fall, the value of these assets increases (bond prices move inversely with interest rates). Go as long out on the yield curve as you can. Then when the Fed inevitably rides to the rescue, begin to unwind and capture the capital gains. Or not. Instead, just continue to receive above-market rate interest payments. There's risk here because there's no way to know how low long-term rates will fall before reversing course (and eroding any capital gains you might have picked up).

Raidion 7y ago
Also worth noting that if you go long, and there is a stimulus required, you may be in trouble as rates are low enough that you can lose money to inflation. No free lunch.
- smaddox 7y ago
  If a stimulus is required (which it definitely will be when the next downturn hits, unless we want the worst depression in history), we'll be begging for inflation. But there will be massive deleveraging and the resulting deflation to compete with. All the while, there will be fools crying for austerity, and business men thinking a sovereign government with the power to issue currency should be run like a business (i.e. tightening the belt during a downturn).
Gpetrium 7y ago
Those are some great points you have raised, I just want to add: When actors are aware of the risks and exposures, they can sometimes inadvertently move the goal post further into the future due to their actions. In this case, the movements made by Central Banks and others may have led to the longest continuous economic growth in US history. I would argue that the government's decision to delay the $150b tarifs was in part to delay the upcoming recession to help support retail & manufacturing numbers in the end of year sales. I agree there is an inevitable recession, it is now a matter of how low it will get, how quick it can bounce back, its ramifications to the world, how it may impact your life and the strategy you intend to have to hedge the risks.
nguoi 7y ago
You don't have a time machine. Economic indicators work every time - until they don't. >Notice how even getting close to zero spread can sometimes be followed by a recession. But a negative spread always does. Everything since the last recession is, on some timescale, followed by a recession. So, technically, you'll be correct. But so were the people saying this in each of the years since 2008. If you don't have an upper bound on this, it's unfalsifiable and, when taken as advice, can't be used for any concrete actions. If investors were as certain as you, a recession would be happening now.
- ganeshkrishnan 7y ago
  The main issue here is that events like these become a self fulfilling prophecy. Since 100% of inverting yield curves have resulted in recessions in the past, stock market investors will start behaving as if an recession is inevitable which in turn starts the recession. The only way this would not turn into recession is if the tariff's are withdrawn or fed lowers the rate even further or with quantitative easing. Any of these would prolong the recession
  - ozim 7y ago
    There are couple more points why it would not turn into recession. Last 10 years people bought a lot more ETFs so it is not like someone will call their broker screaming "SELL SELL SELL". Online brokers are a thing now but you have much more data visible in online interfaces. Like fees for selling all your stuff "RIGHT NOW". With more information easily available and people understanding what ETFs are, there is a huge stabilizing element in stock market. Games and internet goods are now real, not like 2008 or at the time of .com bust. Though those things are still virtual in essence but they affect real life much more than earlier. So even if there is manufacturing slowdown, no one has numbers on how much people are spending on virtual stuff. Sales of books, movies, software went really up, because delivery mechanisms of today were not there 10 years ago. People who knew technology like me 10 years ago did not had money to spend it on virtual stuff. People who grew up playing computer games are now in their 40ies or 30ies. Now they have money and can spend it on stuff that previous gen was seeing as stupid. That said virtual goods market still has plenty of potential to grow. There are multiple jobs to fill for filtering and creating content. There was no such thing as "influencer" or full time youtuber 10 years ago. In the end, no there is no artificial intelligence or algorithm that can filter original content or create one. Manufactured good you can sell once, virtual good you can create once and sell to everyone.
cletus 7y ago
I'd just like to point out that the yield curve inverted in 2018 [1] yet here we are. > Prepare for the inevitable recession. It's not different this time. This point is tautological. Of course there will eventually be a recession. No one can say when. There are different factors in every cycle. The QE period is essentially unprecedented. The rise of tech stocks in the last 20 years is a once-in-a-century type structural change in the economy. It's fair to say the market is currently closer to the top than the bottom and above the historical mean and a reversion to mean is inevitable but whether the current mode goes on for days, months or even years is anyone's guess. [1] https://www.bloomberg.com/opinion/articles/2018-12-03/u-s-yield-curve-just-inverted-that-s-huge https://www.bloomberg.com/opinion/articles/2018-12-03/u-s-yi...
- hn_throwaway_99 7y ago
  > I'd just like to point out that the yield curve inverted in 2018 [1] yet here we are. As pointed out in the article you linked, what happened in late 2018 was a small section (3-5 year treasuries) inverted. When people talk about yield curve being a harbinger of recession, they're usually talking about the 2-10 year spread, which is what the parent post referred to. You may argue "things are different this time", but you shouldn't be comparing apples to oranges.
  - ohyes 7y ago
    Okay, I’ll get my shorts in. What date do you think everything will collapse?
    - mkagenius 7y ago
      The day world war Z II comes out in theatres.
    - govg 7y ago
      It needn't be a "collapse", could be a protracted period of little to no growth, and most indications are that it will start in a couple of years at most.
- 7y ago
clomond 7y ago
"Past Performance Is Not Indicative Of Future Results". I am not saying a recession ISN'T imminent - but to declare affirmatively due to a technical indicator that one IS in an environment which has differences from the past is equally egregious. This yield inversion is based on sentiment, not fundamentals (yet). Also, suggesting folks buy long-term treasuries is literally following what the market is doing right now. Suppose the trade deal is fixed tomorrow and governments add surprise stimulus in the coming months. (by the way, you have a crystal ball as much as I do) If recession fears go away in a few months, those long term treasuries would lose value on the principal and you could very much experience capital losses (if you sell). Also: > Then when the Fed inevitably rides to the rescue, begin to unwind and capture the capital gains. Are you suggesting you can time the market like this? There is abundant literature which says people can't. How are you able to?
- Bombthecat 7y ago
  Yeah, my gut is also telling me, that governments would let half the population starve then let a recession happen.. But if it hits. It will be huge... We might also hit incredible high inflation... Making cash worthless..
- navigatesol 7y ago
  >Suppose the trade deal is fixed tomorrow Do you really believe that's going to happen? The "cold war" with China is heating up. >governments add surprise stimulus in the coming months What happens to interest rates? >If recession fears go away in a few months What do you mean by "recession fears"? People are examining the data and seeing the global economy slowing down; it isn't arbitrary, it's data driven, with the caveat that no indicator is perfect. >*those long term treasuries would lose value on the principal and you could very much experience capital losses (if you sell). Yes, investing has risk. But I find it odd you criticize using simple indicators, then state that if recession fears subside, treasuries will lose value. The value of bonds fluctuates with interest rates, not "recession fears". We can very easily have a bull market with falling rates. It's happened before.
  - navigatesol 7y ago
mherdeg 7y ago
> When the yield between the 10-year and 2-year US treasury inverts, a recession is months away. Cool, so have you bought puts on SPY? What terms did you go with / how much did you buy?
snarf21 7y ago
I think you are right but it won't really hit until 2020 when the administration changes. One thing really helping drive this market is that indexes are driven by a few huge mammoth companies. Additionally, the tax law changes let them bring home tens of billions that they spent on buybacks to drive the price even higher. That was a one time event. Interest rates are already too low and the Fed still has too much paper. There isn't nearly as much powder in the gun this time around. I think this time will be worse than 2008 but time will tell.
adventured 7y ago
> When the yield between the 10-year and 2-year US treasury inverts, a recession is months away. If by "months" you mean nearly two years. "The last inversion of this part of the yield curve was in December 2005, two years before a recession brought on by the financial crisis hit." "A recession occurs, on average, 22 months following such an inversion, according to Credit Suisse." https://www.cnbc.com/2019/08/13/us-bonds-yield-curve-at-flattest-level-since-2007-amid-risk-off-sentiment.html https://www.cnbc.com/2019/08/13/us-bonds-yield-curve-at-flat...
perspective1 7y ago
QE is unprecedented. If you look at the absolute yields, we're talking about rates below inflation (1.8%). It's an inversion but the magnitude is so low it's hard to compare it to past inversions. Equity valuations are pretty much in line with earnings with the S&P 500 index as a whole trading around 20x earnings. Considering how low the risk free rate is (US treasuries), that's not a booming valuation and is probably undervalued if interest rates stay this low considering most of these companies return at least 10% on tangible equity. Unemployment is low right now, but so are wages and so is inflation so it's not like we're booming there either.
- blevin 7y ago
  Regarding precedent: the Bank of Japan began QE in 2001 and has expanded it beyond sovereign bonds to also buy equities and ETF’s. Could the day come when the Fed bids up $BYND?
- sjaknanxnnx 7y ago
  Are you counting the run up to the current prices in your 10% return calculation? That seems kind of circular.
benmarten 7y ago
10y/2y inverted also in 1998, but recession only came in 2001. so 3years later.... it can be long time until recession ;) note that the 10y/3m already inverted though. its more reliable....
- md2be 7y ago
  There is no Evidence that the 10/3 month is more reliable.
Allower 7y ago
>Then when the Fed inevitably rides to the rescue For all your education you are still a fool
papito 7y ago
Tell me about it. I offloaded most of my 401K into Fidelity long-term bond fund, and it's up 20% for the year.
- tunesmith 7y ago
  At some point I have to better understand the weird relationship between bonds and bond funds. If rates are low then bonds are a low performing investment, but apparently bond funds go up.
  - deleted 7y ago
    [deleted]
kickopotomus 7y ago
> When the yield between the 10-year and 2-year US treasury inverts, a recession is months away. > Prepare for the inevitable recession. It's not different this time. Just once can someone put their money where their mouth is? If you are going to say that with such certainty, I expect that you have pulled your money from the market. Perhaps you have even bought a few puts.
AnthonyMouse 7y ago
> Point to consider is the effect of Quantitative Easing (QE). Here, the Fed buys long-term treasuries such as 10-years. This makes long-term rates appear lower than they would otherwise be. It's not just that. The reason yield curve inversions tend to imply recessions is that it's an indication people are taking their money out of stocks and putting it into long-term treasuries. But China just announced a round of currency devaluation. With what's happening in Hong Kong on top of that, it makes people want to dump assets denominated in Chinese currency in favor of ones (like treasuries) denominated in other currencies like USD and GBP. So you get low supply and high demand and what happens? Low long-term bond yields. Consider that recessions are typically caused by something. A decade ago it was the housing crisis, in the 1990s it was the dot com bust, in the 1980s it was savings and loan, in the 1970s it was the oil crisis, etc. So what's the cause supposed to be? It can't be a trade war with China. Some tariffs on a few hundred billion in imports is tens of billions of dollars, which is a rounding error against a $20T economy. There is also too much debt sloshing around which something has to be done about at some point (probably printing a lot of money), but that's been true for years and nothing about it is likely to change overnight one way or the other. So what's the thing that's supposed to be causing this? Because without that it looks a lot like a misleading indicator.

by apo 7y ago

Raidion 7y ago

Also worth noting that if you go long, and there is a stimulus required, you may be in trouble as rates are low enough that you can lose money to inflation. No free lunch.

smaddox 7y ago
If a stimulus is required (which it definitely will be when the next downturn hits, unless we want the worst depression in history), we'll be begging for inflation. But there will be massive deleveraging and the resulting deflation to compete with. All the while, there will be fools crying for austerity, and business men thinking a sovereign government with the power to issue currency should be run like a business (i.e. tightening the belt during a downturn).

Gpetrium 7y ago

Those are some great points you have raised, I just want to add: When actors are aware of the risks and exposures, they can sometimes inadvertently move the goal post further into the future due to their actions. In this case, the movements made by Central Banks and others may have led to the longest continuous economic growth in US history. I would argue that the government's decision to delay the $150b tarifs was in part to delay the upcoming recession to help support retail & manufacturing numbers in the end of year sales. I agree there is an inevitable recession, it is now a matter of how low it will get, how quick it can bounce back, its ramifications to the world, how it may impact your life and the strategy you intend to have to hedge the risks.

nguoi 7y ago

You don't have a time machine. Economic indicators work every time - until they don't. >Notice how even getting close to zero spread can sometimes be followed by a recession. But a negative spread always does. Everything since the last recession is, on some timescale, followed by a recession. So, technically, you'll be correct. But so were the people saying this in each of the years since 2008. If you don't have an upper bound on this, it's unfalsifiable and, when taken as advice, can't be used for any concrete actions. If investors were as certain as you, a recession would be happening now.

ganeshkrishnan 7y ago
The main issue here is that events like these become a self fulfilling prophecy. Since 100% of inverting yield curves have resulted in recessions in the past, stock market investors will start behaving as if an recession is inevitable which in turn starts the recession. The only way this would not turn into recession is if the tariff's are withdrawn or fed lowers the rate even further or with quantitative easing. Any of these would prolong the recession
- ozim 7y ago
  There are couple more points why it would not turn into recession. Last 10 years people bought a lot more ETFs so it is not like someone will call their broker screaming "SELL SELL SELL". Online brokers are a thing now but you have much more data visible in online interfaces. Like fees for selling all your stuff "RIGHT NOW". With more information easily available and people understanding what ETFs are, there is a huge stabilizing element in stock market. Games and internet goods are now real, not like 2008 or at the time of .com bust. Though those things are still virtual in essence but they affect real life much more than earlier. So even if there is manufacturing slowdown, no one has numbers on how much people are spending on virtual stuff. Sales of books, movies, software went really up, because delivery mechanisms of today were not there 10 years ago. People who knew technology like me 10 years ago did not had money to spend it on virtual stuff. People who grew up playing computer games are now in their 40ies or 30ies. Now they have money and can spend it on stuff that previous gen was seeing as stupid. That said virtual goods market still has plenty of potential to grow. There are multiple jobs to fill for filtering and creating content. There was no such thing as "influencer" or full time youtuber 10 years ago. In the end, no there is no artificial intelligence or algorithm that can filter original content or create one. Manufactured good you can sell once, virtual good you can create once and sell to everyone.

cletus 7y ago

I'd just like to point out that the yield curve inverted in 2018 [1] yet here we are. > Prepare for the inevitable recession. It's not different this time. This point is tautological. Of course there will eventually be a recession. No one can say when. There are different factors in every cycle. The QE period is essentially unprecedented. The rise of tech stocks in the last 20 years is a once-in-a-century type structural change in the economy. It's fair to say the market is currently closer to the top than the bottom and above the historical mean and a reversion to mean is inevitable but whether the current mode goes on for days, months or even years is anyone's guess. [1] https://www.bloomberg.com/opinion/articles/2018-12-03/u-s-yield-curve-just-inverted-that-s-huge https://www.bloomberg.com/opinion/articles/2018-12-03/u-s-yi...

hn_throwaway_99 7y ago
> I'd just like to point out that the yield curve inverted in 2018 [1] yet here we are. As pointed out in the article you linked, what happened in late 2018 was a small section (3-5 year treasuries) inverted. When people talk about yield curve being a harbinger of recession, they're usually talking about the 2-10 year spread, which is what the parent post referred to. You may argue "things are different this time", but you shouldn't be comparing apples to oranges.
- ohyes 7y ago
  Okay, I’ll get my shorts in. What date do you think everything will collapse?
  - mkagenius 7y ago
    The day world war Z II comes out in theatres.
  - govg 7y ago
    It needn't be a "collapse", could be a protracted period of little to no growth, and most indications are that it will start in a couple of years at most.
7y ago

clomond 7y ago

"Past Performance Is Not Indicative Of Future Results". I am not saying a recession ISN'T imminent - but to declare affirmatively due to a technical indicator that one IS in an environment which has differences from the past is equally egregious. This yield inversion is based on sentiment, not fundamentals (yet). Also, suggesting folks buy long-term treasuries is literally following what the market is doing right now. Suppose the trade deal is fixed tomorrow and governments add surprise stimulus in the coming months. (by the way, you have a crystal ball as much as I do) If recession fears go away in a few months, those long term treasuries would lose value on the principal and you could very much experience capital losses (if you sell). Also: > Then when the Fed inevitably rides to the rescue, begin to unwind and capture the capital gains. Are you suggesting you can time the market like this? There is abundant literature which says people can't. How are you able to?

Bombthecat 7y ago
Yeah, my gut is also telling me, that governments would let half the population starve then let a recession happen.. But if it hits. It will be huge... We might also hit incredible high inflation... Making cash worthless..
navigatesol 7y ago
>Suppose the trade deal is fixed tomorrow Do you really believe that's going to happen? The "cold war" with China is heating up. >governments add surprise stimulus in the coming months What happens to interest rates? >If recession fears go away in a few months What do you mean by "recession fears"? People are examining the data and seeing the global economy slowing down; it isn't arbitrary, it's data driven, with the caveat that no indicator is perfect. >*those long term treasuries would lose value on the principal and you could very much experience capital losses (if you sell). Yes, investing has risk. But I find it odd you criticize using simple indicators, then state that if recession fears subside, treasuries will lose value. The value of bonds fluctuates with interest rates, not "recession fears". We can very easily have a bull market with falling rates. It's happened before.
- navigatesol 7y ago

mherdeg 7y ago

> When the yield between the 10-year and 2-year US treasury inverts, a recession is months away. Cool, so have you bought puts on SPY? What terms did you go with / how much did you buy?

snarf21 7y ago

I think you are right but it won't really hit until 2020 when the administration changes. One thing really helping drive this market is that indexes are driven by a few huge mammoth companies. Additionally, the tax law changes let them bring home tens of billions that they spent on buybacks to drive the price even higher. That was a one time event. Interest rates are already too low and the Fed still has too much paper. There isn't nearly as much powder in the gun this time around. I think this time will be worse than 2008 but time will tell.

adventured 7y ago

> When the yield between the 10-year and 2-year US treasury inverts, a recession is months away. If by "months" you mean nearly two years. "The last inversion of this part of the yield curve was in December 2005, two years before a recession brought on by the financial crisis hit." "A recession occurs, on average, 22 months following such an inversion, according to Credit Suisse." https://www.cnbc.com/2019/08/13/us-bonds-yield-curve-at-flattest-level-since-2007-amid-risk-off-sentiment.html https://www.cnbc.com/2019/08/13/us-bonds-yield-curve-at-flat...

perspective1 7y ago

QE is unprecedented. If you look at the absolute yields, we're talking about rates below inflation (1.8%). It's an inversion but the magnitude is so low it's hard to compare it to past inversions. Equity valuations are pretty much in line with earnings with the S&P 500 index as a whole trading around 20x earnings. Considering how low the risk free rate is (US treasuries), that's not a booming valuation and is probably undervalued if interest rates stay this low considering most of these companies return at least 10% on tangible equity. Unemployment is low right now, but so are wages and so is inflation so it's not like we're booming there either.

blevin 7y ago
Regarding precedent: the Bank of Japan began QE in 2001 and has expanded it beyond sovereign bonds to also buy equities and ETF’s. Could the day come when the Fed bids up $BYND?
sjaknanxnnx 7y ago
Are you counting the run up to the current prices in your 10% return calculation? That seems kind of circular.

benmarten 7y ago

10y/2y inverted also in 1998, but recession only came in 2001. so 3years later.... it can be long time until recession ;) note that the 10y/3m already inverted though. its more reliable....

md2be 7y ago
There is no Evidence that the 10/3 month is more reliable.

Allower 7y ago

>Then when the Fed inevitably rides to the rescue For all your education you are still a fool

papito 7y ago

Tell me about it. I offloaded most of my 401K into Fidelity long-term bond fund, and it's up 20% for the year.

tunesmith 7y ago
At some point I have to better understand the weird relationship between bonds and bond funds. If rates are low then bonds are a low performing investment, but apparently bond funds go up.
- deleted 7y ago
  [deleted]

kickopotomus 7y ago

> When the yield between the 10-year and 2-year US treasury inverts, a recession is months away. > Prepare for the inevitable recession. It's not different this time. Just once can someone put their money where their mouth is? If you are going to say that with such certainty, I expect that you have pulled your money from the market. Perhaps you have even bought a few puts.

AnthonyMouse 7y ago

> Point to consider is the effect of Quantitative Easing (QE). Here, the Fed buys long-term treasuries such as 10-years. This makes long-term rates appear lower than they would otherwise be. It's not just that. The reason yield curve inversions tend to imply recessions is that it's an indication people are taking their money out of stocks and putting it into long-term treasuries. But China just announced a round of currency devaluation. With what's happening in Hong Kong on top of that, it makes people want to dump assets denominated in Chinese currency in favor of ones (like treasuries) denominated in other currencies like USD and GBP. So you get low supply and high demand and what happens? Low long-term bond yields. Consider that recessions are typically caused by something. A decade ago it was the housing crisis, in the 1990s it was the dot com bust, in the 1980s it was savings and loan, in the 1970s it was the oil crisis, etc. So what's the cause supposed to be? It can't be a trade war with China. Some tariffs on a few hundred billion in imports is tens of billions of dollars, which is a rounding error against a $20T economy. There is also too much debt sloshing around which something has to be done about at some point (probably printing a lot of money), but that's been true for years and nothing about it is likely to change overnight one way or the other. So what's the thing that's supposed to be causing this? Because without that it looks a lot like a misleading indicator.