Recession Oncoming- Forecasted by the Inverted Yield Curve

If the financial markets have a crystal ball, it would be everyone’s dream to grab hold of it.

Today, we are going to share with you, an indicator that has successfully preceded a recession since 1955 except for once in the mid-1960s. There was an economic slowdown rather than a recession but the forecasting prowess should not be undermined.

Uncannily, the latest inversion was in 2019 that preceded the market crash caused by Covid 19 in March 2020.

 

Source: JP Morgan Asset Management – For the 2020 recession in April, it took 8 months to recession after the inversion.

On April 1st 2022, the 2 years and 10 years of US Treasuries rate saw an inversion again. It would be foolish to ignore it given their track record of predicting a recession and economic slowdown.

 

What is an Inverted Yield Curve?

An inverted yield curve is simply a situation where the shorter-term yield is higher than the longer-term yield which is abnormal. It is like you put in a 1 year fixed deposit with an interest of 2% as compared to getting 1% for putting in a 3 year fixed deposit.

From what we learned from our finance professors, we should be compensated more for placing funds for a longer period of time due to liquidity preference theory. There would be more risk involved and our funds will be tied down longer which justifies a higher interest rate naturally.

An inverted yield curve would slant towards the expectation theory which would supersede the liquidity preference theory.

It is the market expectation of future interest rate and a lower expected interest rate in the future would lead to an inverted yield curve.

An expectation of a lower interest rate would signify an economic slowdown or a recession that will lead to a reduction in interest rate to spur up the economy.

 

Do we head for Shelter Now?

Source: www.advisorperspective.com- For the latest inversion in 2019, it took 6 months to reach the market top.

However, an inversion does not straight lead to a market decline. It took an average of 14 months before the recession happens based on precedents. The market would peak earlier than the recession as it is a leading indicator. So there could still be room for the markets to inched further up since we just saw an inversion in April. 

Given the current backdrop, with runaway inflation and quantitative tightening, the odds of a huge upside for the market from here onwards would be of lower probability.

Moreover, the growth and technology stocks have already seen a catastrophic sell-off and it seemed to have not found a bottom yet.

The value and old economy stocks are now holding and supporting the market at the moment as funds flow is into value again after a long hiatus.

 

Chartist Angle

Source: Futu MooMoo- S&P 500 chart as of 22/4/2022

Looking at the charts of the S&P 500, the structure seems vulnerable and if 4100 does not hold, it could be the confirmation of a downtrend. The saviours at the moment could be the commodities, oil and gas, and the consumer staples to help balance out losses from the other sectors.

 

Summing Up

An inverted yield curve has predicted 10 recessions since 1955 and should not be taken as a fluke but an occurrence that we should give great attention to. In this round, the timeframe for the recession or the market to peak could be shorter than the average due to the economic and geopolitical backdrop.

It is therefore a wise move to play defence in the current stage of the investing environment.

We are currently bullish on gold, commodities stocks, consumer staples and value stocks. The demise of growth stocks in recent times has made them attractive with Netflix trading at a PE of 20, PayPal at 25 and Meta at 13.

For the China Tech Stocks, we would prefer exposure through an HSTech ETF that will have exposure to good names such as Tencent, Alibaba, Meituan, JD.com, etc. A dollar-cost averaging strategy would be the most optimal for growth or technology stocks given the current market conditions.

 

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Disclaimer:

The content here is for informational purposes only and should NOT be taken as legal, business, tax, or investment advice. It does NOT constitute an offer or solicitation to purchase any investment or a recommendation to buy or sell a security. The content is not directed to any investor or potential investor and may not be used to evaluate or make any investment. Do note that this is not financial advice. If you are in doubt as to the action you should take, please consult your stockbroker or financial advisor.