The big news on August 15th announced an impending recession due to an inverted yield curve. Some clients may have been surprised to see that as a major headline since there have been other headlines over the past few months saying the exact same thing, just without an 800-point drop in the market. The goal of this update is to explain what an inverted yield curve is and what it means for your investments.
What is an Inverted Yield Curve?
It’s important to start by differentiating the stock and bond markets from the economy. The markets react to what is happening in the economy and then try to predict what will happen next. In this case, the bond market has been reacting to slower global growth by paying less interest for long-term bonds. Usually, an investor expects to get paid more (higher yield) for buying a long-term bond because there is more risk and uncertainty than with a short-term bond. The headlines on August 15th reflect that 10-year Treasury bonds are paying less interest than 2-year bonds (which, for perspective, was accurate by 0.022% and lasted for less than a day). However, the yield curve isn’t 100% accurate in predicting a recession, nor can it predict when the recession will start or how long it will last. The yield curve inverted in late 1966 right before an extended period of economic growth and there was also a brief inversion in 1998 when the yield curve was very flat, similar to our current environment, which also didn’t accurately predict a recession.
What does an Inverted Yield Curve Mean to You?
As noted earlier, yield curve inversions aren’t necessarily 100% accurate at predicting an economic recession. In addition, they don’t predict when the recession will start as the average time between the yield curve inverting and the start of a recession is about 15 months. As shown in the following graphic, we don’t plan to have an immediate investment reaction because the markets can continue to go up for a long time even if a recession does happen.
Our investment reaction to an eventual recession and market decline will be to stay disciplined in maintaining fully diversified portfolios, make sure we have plans in place to meet cash flow needs, take advantage of opportunities to harvest tax losses or rebalance portfolios, and continue to provide a helpful perspective for our clients. The impact of market corrections is included in the calculations we use to build financial plans and invest portfolios so our goal will be to stay fully invested. It is important to remember that any attempt to time the market actually requires two decisions, when to sell and when to buy. We prefer to rely on historical evidence as reflected in the following graphic which reflects the importance of being in the markets for the long haul with a fully diversified portfolio.
We hope this has been a helpful discussion of an important topic. Please feel free to reach out to your team at Flourish Wealth Management if you have specific questions about your account or for additional market perspective.
