Dear clients and friends,
The stock market was shaken by an indicator called a yield curve inversion. What this means is that 2 year government bonds were paying a higher interest rate than 10 year bonds. This is unusual and fundamentally shouldn’t be. The theory is that there is more demand for long term bonds because of perceived short term weakness in the economy. This makes the price of the long term bonds go up, and therefore the yield go down.
The reason the market is concerned by this is that there is a high correlation between this indicator and a coming recession. This indicator does not have a 100% track record, however, and the coming recession that it has predicted in the past has taken as long as 2 years or more to come to pass. Historically, after one of these signals, the market drops about 5% and on average rallies about 17% after that, before falling due to recession. To me, that reads as if this is a bullish indicator at least in the medium term.
Another point to take into consideration is that the Fed is playing a huge role in artificially controlling interest rates. This makes any indicator based on these rates suspect.
Our plan at the moment is to wait and see how the market reacts until there’s a larger overall move. There have been some big days, but the overall move from the peak isn’t that big in terms of percentage points. If the drop continues, we intend to purchase more stocks, and keep a close eye on profits to see if a recession actually is looming. On the bond side, our bonds have gone up in value, so we will start leaning more towards the short end of our bond ladder and when interest rates climb once again, we will once again go longer.
As always, please don’t hesitate to contact us with any specific concerns or questions.
Sincerely,
Alex Parrs
Investment Advisor
alex.parrs@ironwoodfinancial.com
