One of the most prevalent market news items of late is the fact that the yield curve is flattening and may be an indicator of a recession. Matt Phillips of the New York Times published a wonderfully digestible article, if not provocatively titled, “What’s the Yield Curve? ‘A Powerful Signal of Recessions’ Has Wall Street’s Attention” on this subject on June 25th, 2018. Mr. Phillips gives a succinct run down so I won’t get into another inversion discussion here other than to say yield curve inversion is when short-term interest rates are higher than long-term rates, which is the opposite of the normal relationship of short and long-term rates. No matter what the nerdy specifics of the yield curve may be, we think it is important is to get a realistic perspective on how an inversion will affect our investment process and portfolio values.
And so we offer the following summary points.
- History says yield curve inversion may predict a coming recession but it has yet to give us a level of severity or a point in time when one may occur.
- One could reasonably expect Utilities, Consumer Staples, REITs, and companies with steady well-covered dividends to outperform the broader market in a recession.
- A well-diversified portfolio managed by folks looking for companies with wide business moats and strong financials should navigate a recession with more ease than some others.
- One of the reasons longer rates are not higher is because of advancements in technology, which suppress inflation.
- Recessions, like economic expansions, do not last forever. The job of the investor is to invest through the recession to reap the rewards of expansion.
So don’t get too nervous. If the Yield Curve does invert and predict a recession, there are ways to create positive returns. Our job as investors is to stay alert, stay diversified, stay invested, and stay on program.
The steeper Yield curve is from June 2004 as compared to the flatter yield curve from June 2018. Source US Department of Treasury website www.treasury.gov