Blue Bell PWM


Thoughts on the Yield Curve Inversion

Scott Miller, Jr.

Scott Miller, Jr.

Managing Partner

August 15, 2019

Our Thoughts on the Yield Curve Inversion

The Trade “war of words” between the United States and China has been yo-yoing markets for the better part of the summer and may continue until both sides come to a finalized agreement. Most analysts agree that the US economy is the best suited economy in the world to withstand a slowdown, but the major concern has been, could a prolonged trade war cause a worldwide recession?

Market participants have been searching for any sign of a recession and yesterday the yield on the 10-year treasury fell below the yield on the 2-year treasury. This is known as an inversion in the yield curve and could be a sign of an impending recession. In other words, investors are demanding a higher return for short term government paper (2yr treasuries) then for long term bonds (10 y r treasuries) which may signal a loss of confidence in the economy. While worries about trade talks have persisted the inversion in yield curve was the first sign of a potential recession.

Dr. David Kelly of JP Morgan conducted a recent call addressing these issues. Below are the highlights from that call.

 Dr Kelly estimates that there is 40-60% chance that we avoid recession, but it is the closest we’ve been since the 2008 financial crisis, but any recession would be a mild one. He notes “recession psychology” in which investors hear recession and think of 2008 or hear bear market and think of 2008 or 2000. He does not for see a repeat of either of these events

Dr. Kelly points to the China trade dispute as a primary factor contributing to a potential recession but notes that tariffs are not necessarily the cause but rather the uncertainty around tariffs. A speedy resolution could fix the problem fairly quickly.

Below are the reasons that he thinks a recession could be avoided:

  • The US economy is fairly insulated from a worldwide slowdown. He points to the 1998 Asian crisis that didn’t come close to affecting the U.S. The U.S. is mainly affected by what happens within the U.S. economy.
  • There doesn’t appear to be any cyclical boom in economy, there isn’t a dotcom bust like 2000 or a housing bust like 2007, 2008. As Dr. Kelly stated, “It is hard to injure yourself jumping out of the basement window.”
  • Almost all U.S. recessions have been preceded by rises in oil prices. There are currently no signs of higher oil prices.
  • Interest rates are very low. No one is waiting to invest because rates are too high.
  • A trade resolution could fix the problems very quickly.
  • Banks are much better capitalized than they were in 2008

Below are the reasons why we could go into recession:

  • A prolonged trade war with no resolution could increase uncertainty and hinder corporate spending
  • Recessions are half confidence and simply talking about a recession could cause a recession
  • Fading effects of 2017 Tax Cut. The tax cuts encouraged some investment and consumer spending in 2018 but is beginning to fade and may have pulled from future spending.
  • Weak demographics, the working age population growing by only .2% per year. It is this segment of the population that purchases homes, cars, etc.
  • Foreign bond buyers are moving into U.S. markets especially Asian buyers. This may be distorting yield curve itself.

Dr. Kelly notes that on a historical basis US stocks are not overvalued and are probably fairly valued based on their current forward P/E ratio.

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Thoughts on the Yield Curve Inversion

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