Could the yield curve be telling us a recession and bear market is not far behind? And what could Eurozone growth mean for the strength of our bull market? Get the details in this week’s edition of Steady Investor’s Week.
Uneasiness at the Fed over Yield Curve – based on the minutes from the December Fed policy meeting, it seems clear to us that Fed officials are more than marginally concerned about the flattening – and perhaps eventual inversion – of the yield curve. We’ve written many times before that, historically, an inverted yield curve in the U.S. portends recession, and it is an indicator we have been watching closely. The Fed also appeared to express concern over the same issue in December, as minutes from the meeting revealed a relatively lengthy discussion about the recent shrinking of spreads between short-term and long-term interest rates. As it were, the spread between the 2-year and 10-year U.S. Treasury has fallen to its lowest since October 2007, when the U.S. economy was nearing a profound recession. We believe that what investors should be watching from here is the yield on the 2-year U.S. Treasury relative to the 10 and 30-year U.S. Treasury, and when and if the short end of the yield curve ends up higher than the long end of the curve. When that happens, net interest margins for banks could collapse and loans could become virtually unprofitable, which could in turn stifle economic activity. Using history as a guide, recessions have tended to follow. Based on the minutes of the Fed meeting, Fed officials’ project that continued normalization of interest rate policy may cause the yield curve to invert by 2020.
Temporary Setback for the Auto Industry? In 2017, the U.S. auto industry – which has seen solid growth overall in this expansion – suffered a minor setback posting its first annual sales decline since the financial crisis in 2008. We believe that the fact that 2017 vehicle sales were down from a year prior should not necessarily be a cause for concern, however, since sales were coming from a previous all-time high. Indeed, vehicle sales in 2017 topped 17 million for the third year in a row, but year on year growth was down a modest 1.8%. Overall, the domestic car business appears healthy to us despite the minor pullback, but 2018 could pose some challenges as interest rates creep higher and fuel prices could follow with firming crude oil prices. Vehicle makers are reducing North American production in anticipation of softening demand (according to the Wall Street Journal).
Crude Oil Rebounds – crude oil prices have opened the year above $60 a barrel for the first time in four years, arguably boosted by government protests and growing unrest in Iran. Given that Iran is the 3rd largest producer of OPEC countries the unrest could have reverberations on global supply. As crude crosses the $60 a barrel mark, it is also interesting to note that shale production becomes profitable – which could boost activity in the sector. In a survey last month of more than 100 oil industry executives, the Dallas Federal Reserve found that 42% would expand shale drilling with crude prices between $61 to $65. An additional 31% would increase investment when prices top $66 (according to Seeking Alpha).
Eurozone Growth – one of the potential drivers of the bull case in the U.S. and globally is firm economic activity in Europe, as was evidenced this week by perceived solid readings in manufacturing activity for the region. Countries appear to be ramping up activity at the fastest pace in more than two decades, with IHS Markit’s December final manufacturing PMI reading hitting 60.6. New orders rose at a near-record pace, while purchasing growth hit a new peak.
While we believe that strong growth in Europe is a positive indicator of a bull market, the yield curve flattening could make a case that we need to be prepared for a potential correction or a bear market.
So now the question to you, “Is your portfolio prepared for any potential bear market?”
My guess is that you are unsure of the answer…but the answer is important. That is why we offer a free Portfolio Stress Test that may help analyze how your portfolio would perform during the next bear market.
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