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STA Weekly Report – Yield-Curve Inversion Triggers Recession Fears

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INSIDE THIS EDITION:
Yield-Curve Inversion Triggers Recession Fears
Weekly Technical Comment|
Weekly Snapshot of Global Asset Class Performance
401k Plan Manager

Last Wednesday, U.S. stocks suffered a deep sell-off with the S&P 500 sinking nearly 3% by market close. The move lower was sparked by the fact that the 10-year Treasury rate slid below the two-year Treasury rate for the first time since 2007. In other words, the yield curve inverted as the spread between 10-year and 2-year Treasury yield turned negative.

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Why do equity investors care so much about the Treasury yield curve? Because it signals fears of an economic slowdown and has preceded each of the last five U.S. recessions. So, it is a big deal, especially from a psychological standpoint.

The New York Fed has a recession forecasting model based on the shape of yield curve that currently predicts over 30% likelihood of a recession in the next 12 months, the highest reading since the end of global financial crisis. Similarly, economists surveyed by Bloomberg put recession odds at 35%.

No one should ignore the warning signs sent by the bond market. After all, the global economy is slowing, most notably in manufacturing sectors and export-oriented economies. But investors don’t need to panic, either. Let’s look at yield curve inversions from a historical perspective to add additional context to this most recent shift. First, it should be noted that a yield curve inversion does not portend that a recession is imminent.  Instead, it tends to surface about 12 to 18 months before a recession, as highlighted by the yellow bars in the chart below.

Second, not all yield curve inversions are followed by recessions. In 1998 and again in 2006, the yield curve briefly inverted (highlighted by red arrows in the following chart). In both instances a recession never materialized indicating that the model is occasionally prone to false-positives.

Third, the stock market can continue trending higher, even following a yield curve inversion (highlighted by the green arrows below). So, getting out of the market simply because of a yield curve inversion may prove costly to investors as they potentially miss further gains.

It is also worth mentioning the changed dynamics in the treasury markets caused by massive Quantitative Easing (QE) programs. The result of these programs has been a suppressed long-term bond yield, which also has made it easier for the long-term yield to fall below the short-term yield.

Another important word of caution is that the U.S. yield curve may no longer serve as a relevant indicator for the U.S. economy. As foreign capital has flowed into the U.S., investors have piled into bonds offering higher yields than are available in many other parts of the world. German GDP contracted 0.1% in the second quarter, the EU faces a potential loss of the U.K. without a negotiated exit, and China’s industrial output rose 4.8% in July. These economic data points have been disappointing and have narrowed the spread of foreign yield curves to zero or below, dragging down the U.S. yield curve.  

Although we provide some evidence here to downplay the significance of an inverted yield curve, we believe that it is time to build a more defensive portfolio. While we don’t believe getting out of the market completely and holding large cash positions is the right move, we do favor owning lower volatility equities while prioritizing capital preservation over yield within bond portfolios. These measures should help navigate a challenging environment and higher volatility when it emerges.

State of the Stock Market

The performance for the S&P 500, S&P Mid-Cap 400 and S&P Small-Cap 600 over the last 3, 6, 9 and 12 months pretty much says it all. The S&P 500 is positive on all four timeframes, the S&P Small-Cap 600 is negative on all and the S&P Mid-Cap 400 is mixed. Mr. Market is about as split as can be.

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The chart below shows 3-month performance for eight stock indexes and the overall picture is mixed. The S&P Small-Cap 600, Russell 2000 DJ Microcap Index are negative, while the S&P Mid-Cap 400 and S&P 500 Equal-Weight Index are barely positive. The S&P 500, Nasdaq 100 and Dow are up and doing the heavy lifting.

Even though the S&P 500 is positive on the 9- and 12-month timeframes, there was a sizable dip in the fourth quarter of 2018 and the index was down 19.78% from its September closing high on December 24th. Yes, the index was 0.23% away from bear market territory (down more than 20%) and rallied back with a vengeance. Sorry, but you cannot measure correction territory or bear market territory with a simple percentage move in one index.

The chart above shows one-year performance for these three since August 2018, which is when the S&P Small-Cap 600 peaked. Despite double digit gains since the December low, the S&P Small-Cap 600 (red line) and S&P Mid-Cap 400 (blue line) never fully recovered from last year’s decline. The S&P 500 turned positive again in April and again this summer, but it is up just 2.14% over the past year. It would not take much to turn the 1-year Rate-of-Change negative again.

S&P 500 Remains in Uptrend

Technically, the S&P 500 SPDR (SPY) remains in a long-term uptrend. The index hit a new high in late July and remains well above the prior reaction low (trough in early June). Thus, price action still shows higher highs and higher lows. In addition, the 20-day SMA is above the 200-day SMA and price is above the 200-day SMA. The S&P 500 breadth indicators are still net bullish, but the Index Breadth Model is net bearish because of mid-caps and small-caps (see below). What a mess!

Trading has turned quite choppy here in August and some guy named Powell is speaking in some place called Jackson Hole. After the sharp decline in early August, the index consolidated with a rising flag type pattern. SPY is holding near the top of this range after a two-day bounce. There is some resistance in the 295 area from the mid-August highs and 50-day SMA (not shown). In addition, RSI is near 50, which is the make-or-break area for a short-term bounce. 

Weekly Global Asset Class Performance

If you have any questions, please feel free to email me at luke@stawealth.com.

Luke

STA Investment Committee
Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)


Caring of Your Aging Parents

By Scott A. Bishop, MBA, CPA/PFS, CFP

Mom? Dad? We need to talk

Later this month I will be hosting a very important episode of the STA Money Hour with author and Journalist Cameron Huddleston.  I have been interviewed by and hosted past STA Money Hour shows with Cameron in the past on “Money Worries”.  This issue is near and dear to me as I have had to deal with this issue with many of my personal family members.

Cameron recently wrote a book called “Mom and Dad We Need to Talk – How to Have Essential Conversations with your Parents About their Finances” – I would encourage all of you to check out her book (in the prior link).

Caring for your aging parents is something you hope you can handle when the time comes, but it’s the last thing you want to think about. Whether the time is now or somewhere down the road, there are steps that you can take to make your life (and theirs) a little easier. Some people live their entire lives with little or no assistance from family and friends, but today Americans are living longer than ever before. It’s always better to be prepared.

The first step you need to take is talking to your parents. Find out what their needs and wishes are. In some cases, however, they may be unwilling or unable to talk about their future. This can happen for a number of reasons, including:

  • Incapacity
  • Fear of becoming dependent
  • Resentment toward you for interfering
  • Reluctance to burden you with their problems

If such is the case with your parents, you may need to do as much planning as you can without them. If their safety or health is in danger, however, you may need to step in as caregiver. The bottom line is that you need to have a plan. If you’re nervous about talking to your parents, make a list of topics that you need to discuss. That way, you’ll be less likely to forget anything. Here are some things that you may need to talk about:

  • Long-term care insurance: Do they have it? If not, should they buy it?
  • Living arrangements: Can they still live alone, or is it time to explore other options?
  • Medical care decisions: What are their wishes, and who will carry them out?
  • Financial planning: How can you protect their assets?
  • Estate planning: Do they have all of the necessary documents (e.g., wills, trusts)?
  • Expectations: What do you expect from your parents, and what do they expect from you?

Preparing a personal data record

Once you’ve opened the lines of communication, your next step is to prepare a personal data record. This document lists information that you might need in case your parents become incapacitated or die. Here’s some information that should be included:

  • Financial information: Bank accounts, investment accounts, real estate holdings
  • Legal information: Wills, durable power of attorneys, health-care directives
  • Funeral and burial plans: Prepayment information, final wishes
  • Medical information: Health-care providers, medication, medical history
  • Insurance information: Policy numbers, company names
  • Advisor information: Names and phone numbers of any professional service providers
  • Location of other important records: Keys to safe-deposit boxes, real estate deeds

Be sure to write down the location of documents and any relevant account numbers. It’s a good idea to make copies of all of the documents you’ve gathered and keep them in a safe place. This is especially important if you live far away, because you’ll want the information readily available in the event of an emergency.

Where will your parents live?

If your parents are like many older folks, where they live will depend on how healthy they are. As your parents grow older, their health may deteriorate so much that they can no longer live on their own. At this point, you may need to find them in-home health care or health care within a retirement community or nursing home. Or, you may insist that they come to live with you. If money is an issue, moving in with you may be the best (or only) option, but you’ll want to give this decision serious thought. This decision will impact your entire family, so talk about it as a family first. A lot of help is out there, including friends and extended family. Don’t be afraid to ask.

Evaluating your parents’ abilities

If you’re concerned about your parents’ mental or physical capabilities, ask their doctor(s) to recommend a facility for a geriatric assessment. These assessments can be done at hospitals or clinics. The evaluation determines your parents’ capabilities for day-to-day activities (e.g., cooking, housework, personal hygiene, taking medications, making phone calls). The facility can then refer you and your parents to organizations that provide support.

If you can’t be there to care for your parents, or if you just need some guidance to oversee your parents’ care, a geriatric care manager (GCM) can also help. Typically, GCMs are nurses or social workers with experience in geriatric care. They can assess your parents’ ability to live on their own, coordinate round-the-clock care if necessary, or recommend home health care and other agencies that can help your parents remain independent.

Get support and advice

Don’t try to care for your parents alone. Many local and national caregiver support groups and community services are available to help you cope with caring for your aging parents. If you don’t know where to find help, contact your state’s department of eldercare services. Or, call (800) 677-1116 to reach the Eldercare Locator, an information and referral service sponsored by the federal government that can direct you to resources available nationally or in your area. Some of the services available in your community may include:

  • Caregiver support groups and training
  • Adult day care
  • Respite care
  • Guidelines on how to choose a nursing home
  • Free or low-cost legal advice

Once you’ve gathered all of the necessary information, you may find some gaps. Perhaps your mother doesn’t have a health-care directive, or her will is outdated. You may wish to consult an attorney or other financial professional whose advice both you and your parents can trust.


Important Disclosure:
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.

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