the bear market ALMANAC
than two years from now, so you’re supposed to get a higher yield when you buy longer- term bonds to account for that risk. But sometimes the yield curve “inverts,” and shorter-term bonds pay better yields than long-term ones. This happens when investors expect lower interest rates, lower inflation, or even deflation in the future. These things would normally happen only if the economy gets bad. This “inverted yield curve” happened in late August... So, does the yield curve predict recessions and bear markets? It’s not a good sign. When we see a recession, it’s likely that it was preceded by a negative yield curve. However, the yield curve also gives a lot of false signals. Here’s what we can say for sure... the curve has inverted, and that means a bear market tends to come in the next few months. A recession follows a few months after that. At the same time, we have to recognize we are in a unique time for monetary policy. The Federal Reserve over the past few years has been raising short-term rates. That could make an inverted yield curve a weaker signal than it has been in the past. A DEBT COLLAPSE You can get a bear market without a debt crisis, but you can’t have a debt crisis without a bear market. Debt moves in cycles. When times are good, money is cheap. Lenders are willing to lend. As times stay good, lenders forget discipline
This tells us a few things... First, markets climb slowly and for a long time, then correct quickly. The bad times last about one-quarter of the duration of the good times. And one surprise jumped out at us... By our definition, the market decline that started last September qualified as a bear market. And then a new bull market was established from the market’s low on Christmas Eve 2018. With our bear markets defined, we can go on to explore when they happen and what you can do about them... WHEN THE BEAR ARRIVES If you follow any financial news, you’ve likely heard dire warnings about the “yield curve” predicting a recession ahead. This is an esoteric financial concept that you never hear about except when its value gets low and financial media need to gin up a headline. And you’ve likely never seen a full breakdown so you can judge its predictive power on its own. The yield curve is the difference between the yields on fixed-income securities maturing at different times. You can use any expiration dates you’d like, though some have emerged to be the standard benchmark. The most common is the difference between 10-year and two-year bonds. Normally, longer-dated bonds have higher yields than shorter-dated bonds. That’s called a “positively shaped yield curve.” The future 10 years from now is always more uncertain
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October 2019
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