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The Week Ahead – Inversion Diversion

| 4/8/19 8:26 AM

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

One of the most watched economic signals is the Treasury yield curve. The yield curve is the amount that the U.S. Treasury pays for bonds across various maturities. Most of the time the curve is upward sloping as investors demand compensation for the risk of owning bonds with longer maturity dates. While the coupon rate is guaranteed, the longer the bond, the more negatively impacted its price will be to rising interest rates.

Two weeks ago we saw the yield curve invert, meaning the 10-year Treasury was yielding less than the 3-month yield. This has traditionally been one of the more accurate indicators of a sharp economic slowdown. Indeed, inverted yield curves have preceded the last seven recessions. However, this is not an exact science. Inverted yield curves have sent false signals in the past.  And, this inversion, which ended last week, was extremely shallow and short-lived. The yield curve was inverted for just six days, and by only few basis points (0.03% to be exact). We would need to see the inversion last at least three months for this indicator to be historically significant. Another important consideration is that, on average, it takes 17 months from the initial inversion for a recession to begin, and it is often preceded by a strong equity market rally:

First Inversion

Market Rally

1989

+43%

1998

+51%

2006

+22%

Average

+39%


Avoiding risk by locking in the certainty that comes with buying a 10-year Treasury is just one of the reasons an investor may prefer a longer dated bond. Another reason U.S. yields remain at historic lows is due to strong demand from global investors. Incredibly, there is now $10 trillion of negative yielding debt around the globe. German 10-year bond yields hover around zero percent, and recently got as low as negative 0.08%. To a foreign investor, 2.5% backed by the strongest economy in the world can seem very attractive. The reason more foreign investors don’t buy more U.S. debt is due to expensive currency hedging costs.

While the gap between short and long-term yields remains slender, economic growth is still relatively good and the stock market tends to perform well for years after the initial inversion. Additionally, with credit markets holding up well, the employment market at its strongest in fifty years, and wages still increasing, we don’t yet see the necessary combination of factors that suggest a recession in the foreseeable future.

~“In investing, what is comfortable is rarely profitable.” –Robert Arnott

Data deck for April 8-April 12:

Date

Indicator

Period

Apr. 8

Factory orders

Feb.

Apr. 9

NFIB small business index

Mar.

Apr. 9

Job openings

Feb.

Apr. 10

Consumer price index

Mar.

Apr. 10

Core CPI

Mar.

Apr. 10

FOMC minutes

 

Apr. 10

Federal budget

Mar.

Apr. 11

Weekly jobless claims

4/6

Apr. 11

Producer price index

Mar.

Apr. 12

Import price index

Mar.

Apr. 12

Consumer sentiment index

Apr.

    

IMPORTANT DISCLOSURE INFORMATION    

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 First Foundation Advisors), or any non-investment related content, made reference to directly or indirectly in this blog 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 blog serves as the receipt of, or as a substitute for, personalized investment advice from First Foundation Advisors. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. First Foundation Advisors is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the First Foundation Advisors’ current written disclosure statement discussing our advisory services and fees is available for review upon request. Please Note: First Foundation Advisors does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to First Foundation Advisors’ web site or incorporated herein, and takes no responsibility therefore. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Brett Dulyea, CFA, CAIA
About the Author
Brett Dulyea, CFA, CAIA
Mr. Dulyea serves as a Portfolio Strategist on the investment team and is responsible for conducting manager research and executing investment strategies for clients. As a member of the investment committee, he provides market commentary and investment insights. Mr. Dulyea’s specializes in advising client portfolios, defining investment plans, and communicating the firm’s investment viewpoints. Prior to joining the firm, Mr. Dulyea was a Director, Portfolio Manager at Deutsche Bank. In addition to working directly with clients, he was a member of the Fixed Income Strategy Group and managed customized portfolios for clients. He previously worked in the Wells Fargo Wealth Management Group as a Vice President, Senior Investment Strategist and at Merrill Lynch as a Vice President, Portfolio Manager. Mr. Dulyea earned his Master’s in Business Administration (MBA) from California Polytechnic University, Pomona and holds the Chartered Financial Analyst® (CFA) designation and the Chartered Alternative Investment Analyst (CAIA) charter. He earned his Bachelor’s degree from the California Polytechnic University, Pomona. He also served as an adjunct Professor of Finance at California Polytechnic University, Pomona for two years. Read more
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