'Yield curve is a troubling sign but recession not imminent'

'Yield curve is a troubling sign but recession not imminent'

Stomachs churned and nervous ticks returned last week as one of the more trusted historical indicators of a recession, the inverted yield curve, sounded a warning klaxon.

It was catnip for the bears, with some analysts proclaiming that the countdown to recession ‘starts now’. The latest market swing - after some losses were trimmed, the S&P 500 is still on track to lose 3% in August – arrived despite the US Federal Reserve handing investors a quarter-point interest rate cut at the end of July.

Two main factors, though, spooked the market: an escalation in the U.S.-China trade dispute and a rush of investors hopping into the relative safety of bonds amid concern over the global economy. The latter was possibly exacerbated by the Fed’s language, which clearly suggested that the priced-in, four-cut scenario was not on the agenda.

US President Donald Trump has done little to appease nervous investors, with his threat to impose more tariffs on China prompting his Far East foes to allow the Yuan to weaken against the dollar.

Portfolio manager Nader Hamid, Total Wealth Management Group, HollisWealth, told WP that while the inverted yield curve on the 2-year and 10-year is a “troubling sign”, it doesn’t mean that a recession will happen immediately.

He said: “Although the yield curve has a history of predicting recessions, it has a very bad history of being a timing indicator. On average, recessions happen about 21-22 months after that inversion, so it’s a big reaction from the market on something that may happen two or three years down the line. One of the things that we're seeing is that, negative-yielding debt, like we have in a lot of European countries, may be a good thing to support asset classes.”

He added that this may be a case of TINA (there is no alternative) when it comes to equities, while low rates and fiscal policy could actually stimulate global growth. “We seeing a very healthy US consumer based on strong employment, low interest rates and low oil prices, which is giving people a lot more disposable income. Those are positive things, which could push a recession out even further.

“[The inverted yield curve] is a troubling sign, but it doesn't mean we're heading for a recession imminently this year.”

Talk of a countdown to a recession beginning “now” is arguably hyperbole and that trying to time it is as futile as trying to time the markets. In terms of protecting his clients, Montreal-based Hamid, after a strong six months, is raising cash and slightly underweighting equities.

He explained: “We still believe in the long-term power of the market. We want to choose our spots to buy back in – we’re not sitting in cash for the long term, it’s just a strategic shift. We like investing in non-correlated asset classes, things in the private sector, private equity, private bonds, and being well diversified and looking for things that are giving us consistent returns.

“Even dividend stocks, the average dividend on the S&P 500 is 2.06, which is much higher than then the current bond and interest-rate yields. It's not a bad place to have good yield while things turnaround and some of the noise dissipates from the market.”

He added: “The recession is going to happen. I mean, the countdown started when the last recession ended! The yield curve inversion didn't start the countdown

“You can’t invest trying to guess when the next recession is going to happen. If we remember, in 2009, 2010, after the big recession, even when things were improving, there were calls for a double dip recession or that were going to fall back in. So even if you could get the events right, the timing makes it very tricky. I wouldn't move away from our long-term objectives and long-term investment strategy because of any of the things we’ve heard [last week]."

Chad Larson, portfolio manager at MLD Wealth Management Group, Canaccord Genuity Wealth Management, told WP that he has increased exposure to gold, which he believes is poised for a run, and commodities, but that investors mainly have to trust in the process and ride out the ups and downs of the expansion.

Sudden hysteria at the inverted yield curve, he said, missed the point that the path to a recession is already happening and, in some sectors like manufacturing, has already arrived.

He said: “It’s more a case of death by a thousand cuts and then we wake up one day and the media decides that we are in a recession. It’s like when a relationship ends and someone changes the status on Facebook – it didn’t end that minute, the writing had been on the wall for a while and there were signs along the way.

“There is also something in the way we consume information these days - with 24-hour news, social media, twitter etc - that rumours spread like wildfire and before you know it, it’s everywhere.

“The markets are like a rollercoaster, you go up and down, up and down, and our job is to educate our clients, keep them informed and make sure they don’t unstrap themselves at the top!”

A warning not to start trying to time market slumps and economic dips also came from Gerry Frigon, president and chief investment officer at Taylor Frigon Capital Management.

He said investors should still base their strategies on the real source of most of the great wealth created for families in this country for the past hundred years - the ownership of shares in successful businesses for years or even decades. In doing this, they should expect both interim volatility and be prepared to weather it.

He said: “Unlike most of what you hear, we advise that investors realize that there will always be ebbs and flows in the mighty financial ocean, but that these by themselves shouldn’t make you change your mind about businesses with solid prospects that you intended to own for many years.

“In the short run, powerful forces can move stocks around the way hurricane winds toss debris. Short-sellers can tear down the price of a company regardless of how solid the long-term business prospects of that company.

“But investors do have one advantage over such ‘fast money’ - the ability to wait. Short-sellers and other players who rely on leverage and borrowing (such as hedge funds) cannot sell a company short for years on end - the nature of such trading is necessarily short-term.”

 


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