Today we’re going to go back by reviewing past recessions. We’ll also be broadening the scope a little bit and taking long term look at the markets and market volatility over the course of the past year. We’re then going to take a look at this yield curve. I have several different interesting charts to show you when it comes to this inverted yield curve. I’m writing this on September 11, 2019, and will be returning for our next Monthly Economic Update in mid-October due to some family travel.
Over the Last 12 Months
Figure 1 Source: ChaikinAnalytics.com
So, let’s get started by taking a quick look at the markets over the course of the past year. As you can see in Figure 1, there was a big drop last year. There are a couple of indices that haven’t recovered at all. Those are the small-cap indices like the Russell 2000 and the S&P 600 Small-Cap. Both of those indices are still significantly down over the course of the last 12 months. You can see most everything else is just about at a breakeven over the course of the last 12 months.
It’s been a rocky ride. The volatility we’ve seen just in the last two or three months feels crazy once again. But I wanted to go back and say, “Okay, here’s what we were experiencing last year.” And the volatility we experienced last fall was far greater than what we’ve experienced so far this year.
Over the Last Six months
Figure 2 Source: ChaikinAnalytics.com
Even if we take a six-month snapshot of where we’re at today in Figure 2, we see some positive numbers out there, but we still see some hovering around zero to 5%. You can see the volatility really start to show itself. The question is becoming, “Okay, what’s causing all the volatility?”
Well, a number of different things right now. You know, some people are going to say, “It’s the trade war dummy?!” or, “It’s what Trump’s tweeting on a daily or weekly or a minute by minute basis!” or, “It’s the market trading on the news!” I’ll agree that news is manipulating the market, it’s causing people to make quick decisions, sometimes emotional decisions and sometimes irrational decisions. However, there’s more to it.
The Yield Curve and Fundamentals
There are fundamentals today causing the markets to feel a little uneasy. We started talking about this in the Monthly Economic Update for March 2019, The Yield Curve Inverted, What You Need to Know. Back in March, the Three-Month Treasury started yielding higher than the 10-Year Treasury. So, today we are going to take a look at the Treasury Yield Curve.
Figure 3 Source: GuruFocus.com
The light gray line in Figure 3 represents the Treasury Yield Curve for September 2017. As you can see, the short-term treasuries, like the One-Month, are down around 1%. If you look toward the long-term treasuries like the 10-Year Treasury are close to 2.5% and higher.
Flattening Yield Curve
Now, by the time we got to September of 2018 (dark gray line), we notice the yield curve is a little bit shallower. It’s kind of flattening out a little bit. That’s why last fall, people started talking about the flattening of the yield curve. That’s what you see here in the dark gray. You can see the lower rates had come up substantially. Yet the 10-Year rates have not come up nearly as substantially on a percentage basis as the short-term rates.
The blue line in Figure 3 is our current yield curve as of September 11, 2019. You can see the inversion. This means everything on the short end is yielding more than the Five-Year, Seven-Year, and in some cases the 10-Year Treasury. There is the inverted yield curve you’ve heard so much about.
Reviewing Past Recessions
Figure 4 Source: GuruFocus.com
What does that really mean? Figure 4 shows the 10-Year to the One-Year spread on the Treasury. This has predicted all past recessions for the last seven recessions. Here’s what happens. If the blue line comes underneath the red line, it means the One-Year is yielding higher than the 10-Year Treasury. As you can see after that happens, a few months later, a recession occurs in the areas shaded in gray.
Learn more about the inverted yield curve in our posts What is Yield Curve Inversion? and What Happens After a Yield Curve Inversion?
The Dot Com Bubble and the Great Recession
You see it happen in the early 2000s with Dot Com Bubble and in 2008 with the Great Recession. During the Dot Com Bubble, the yield curve inverted back early part of 2000, the recession didn’t really occur until 2001. Then with the Great Recession, we had an inversion here in 2006, and the recession didn’t come until late 2008.
Currently, we have the inversion, and it’s there again. So, there’s a kind of a spread somewhere between six and 21 months after a yield curve inversion for the last seven. This isn’t 100% absolute. However, the last several sessions have been predicted by this inverted yield curve.
No One Wants a Recession, but There Will Be Economic Contraction
We are on the lookout here, and the markets are very uneasy about this, the markets don’t want to see a recession. Nonetheless, please remember this; every economic expansion is followed by an economic contraction. Every bull market is followed by a bear market. Recessions happen, it’s natural. This yield curve inversion has the markets very jittery, and it’s what’s causing a lot of this volatility. It’s what’s causing the markets to react so much more violently, to the bits of news that are coming out of Trump’s trade negotiations or “trade war,” his tweets, or anything is going on out there to spook the markets. It’s over exaggerated because of what’s going on with the underlying fundamentals.
Markets During Past Recessions
Figure 5 Source: GuruFocus.com
Now, one more chart here to leave you with this month. Figure 5 is a little bit busy, but the blue line is showing the stock market going all the way back into the 60s. And then the black line is the One-Year Treasury, and the green line is the 10-Year Treasury. This is just showing when the Treasury yields on the One-Year eclipse the 10-Year and then the subsequent recession. The idea behind this Figure 5 is to show you what the markets did during those past recessions. You can see during almost all of the past recessions there was some sort of market pullback.
Now, there have been periods like the early 90s, when the markets had a little blip and just kind of ignored the recession. However, the Dot Com Bubble was much worse, and the Great Recession was much worse. The volatility we’ve seen over the last several months doesn’t look so bad when you compare it to what we saw back in the Dot Com Bubble and the Great Recession.
Daily Volatility vs. Devastating Losses
We want to try and make sure we’re watching out for what I would call devastating losses. Have your portfolio has been more volatile in the last several months? Absolutely, there’s no question about it. There are fundamental reasons behind it. But remember, the idea behind good solid wealth management is to make sure you’re protected, not from daily volatility, but from catastrophic type losses. Losses like we saw back in the Dot Com Bubble and the Great Recession.
You can’t avoid the short-term volatility. It’s nearly impossible to do. And in fact, sometimes the short-term volatility causes a lot of indicators to really get whipped around. So, you have to have a lot of patience during times like this.
Stay in Contact
We have made adjustments to many of our portfolios. Not all of our portfolios have had adjustments, but many of them have. I encourage you as I do every single month to keep the dialogue open with your advisor. Understand what your portfolios are doing, what we’re trying to accomplish overall, and how the portfolio construction that we have for you fits into your overall retirement plan. Keep the lines communication open. Also, remember next month’s Monthly Economic Update will come sometime around mid-October.
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