Inverted yield curve…
The ominous signal that has predicted seven out of seven of the last recessions… in 2007, 2001, 1990, 1981, 1980, 1973, and 1969.
A perfect track record spanning back half a century.
Yet many investors have never heard of an inverted yield curve.
If you’re one of them, then I must warn you that your wealth is at risk.
The signal that has stayed dormant for over a decade is again flashing red.
What exactly is an inverted yield curve… and how can it predict recession?
Why Bond Yields Move Up And Down
When the U.S. government borrows money to pay for its deficits, its military, and other expenses, it does so by issuing bonds. This is just a fancy way of taking out a loan.
Of course, many investors worldwide are eager to lend to the U.S. government, as they feel pretty confident they’ll be paid back.
These bonds/loans come in different maturities. Some last only a month, while others can last up to 30 years.
This is an important point because when you lend money, you typically charge higher interest rates on longer-term loans and lower rates on shorter terms. This is generally the case when the United States borrows. The chances of the U.S. government going bankrupt in the next couple of months are low, while the chances of this happening sometime during the next few decades are less certain.
So, again, under normal circumstances, long-term U.S. government bonds yield more than short-term U.S. government bonds.
Because the United States is one of the most stable countries in the world, the demand for its bonds is high. This means it can shop around to find the best deals—those charging the lowest rate of interest.
Naturally, this demand fluctuates.
When the economy is booming, money is moving out of safe assets, such as bonds, into stocks. In such times, yields rise. There are fewer buyers on the market, so the U.S. government must offer better returns to get the money it needs.
However, when the future becomes uncertain, and there is a risk of recession, money rushes into bonds. Because the demand is high, the government can borrow at a lower price, which means U.S. bond yields decline.
How Does The Yield Curve Invert?
Here’s where this gets exciting…
Because no one knows how long a downturn will last, investors prefer to store their money in longer-maturity bonds. Typically, the most in-demand one is the U.S. 10-Year bond, which forces its yield lower.
At the same time, no one wants to invest in shorter-maturity bonds. The crisis likely will still be a concern a few months or a year hence, when these bonds mature. This pushes shorter-maturity bond yields higher…
Creating a situation where yields on long-term bonds fall below those of short-term bonds. That’s what we in the financial world call the inverted yield curve.
Basically, this means that investors believe there’s a higher chance the government defaults within the next year than 10 years from now. Precisely the opposite of what you would consider logical.
And How Can It Be So Accurate?
Like it or not, financial institutions hold sway over the economy. They control the money streams, invest them into businesses, which can then expand operations, employ new workers, and contribute to GDP growth.
However, when the economy’s future becomes uncertain, be it because of a stock bubble, a trade war, or for any other reason, these institutions become afraid. They pull back on their investments and instead start redirecting money streams into haven assets, such as long-term U.S. bonds.
In the beginning, it’s just conservative players who move in this direction. Soon, though, panic spreads, and, before you know it, everyone is rushing into bonds. When enough of the financial system does this, the yield curve inverts, signaling that fear has reached a critical mass and that the economy is headed for recession.
I’ve been warning about a potential downturn for some time now. That is why I’ve been recommending defensive stocks to my True Retirement Wealth subscribers.
Twelve out of 16 stocks in the portfolio can withstand and even thrive during a recession because their business models are not dependent on economic cycles.
In this month’s issue, I’m adding another such stock that, in addition, comes with an impressive 4.23% dividend yield.
Subscribe now in time to receive this recommendation.