The most reliable economic indicator of the past 50 years is flashing red.
Get your portfolio flashing greenwith 10X more income paid every 20 days.
I refer to the yield curve – a graphic plot of the yields offered by U.S. Treasury securities (of which there are 12).
The yields usually plot low to high: the longer the maturity, the higher the yield.
The yield curve is “normal” when each successive maturity offers a higher yield than one before, as the graph below shows.
Problems arise when the yield curve “inverts”: short-term yields rise above long-term yields.
The yield curve has inverted over the past month.
This is a big deal.
When the yield has inverted – the three-month yield has risen above the 10-year yield – a recession has followed within a year to 18 months. This is the history over the past five decades.
When investors think recession, they think bear market. The two usually arrive hand in glove.
Indeed, the S&P 500 has lost ground with each recession since 1970. It lost a lot of it – 50% – during the last recession.
Now, to answer your question: Why does the yield curve invert?
When the yield curve is normal, bond investors are bullish on the economy. They believe interest rates will rise. They aim to capture higher yield in short-term maturities. Their demand raises price and drops yields on the short end of the curve.
When bond investors believe the economy is headed south, interest rates on the long end will head south, too. Bond investors buy long-term bonds to lock in the higher yields that prevail today. Long-term bond prices rise, their yields fall.
Here’s the key takeaway: Bond investors have been extraordinarily accurate at anticipating recessions.
Great for them, but what about us?
Few of us buy bonds directly. That’s unlikely to change
Then again, why would we buy bonds? Many are poor income options.
Interest rates remain low from a historical perspective, even after the Federal Reserve increased interest rates multiple times over the past two years.
You’re still looking at income yields of 1.7%-to-2.7% on Treasury securities.
If the Fed cuts interest rates, those yields are sure to drop further.
But here’s a useful little secret about inverted yield curves and stocks: Stock prices have frequently climbed after an inversion.
Take the nastiest recession of the postwar era, the Great Recession of 2008-09.
The yield curve inverted in January 2006. When the recession finally arrived in 2008, the S&P 500 had advanced 14.7%.
The next recession is unlikely to be as punishing as the one we endured 11 years ago, but it could still inflict some pain. You want to prepare.
I still think stocks are the place to be for income investors.
That said, pick your battles carefully. Manage your risk.
Quality dividend-paying stocks are a solid option.
The research shows that they’re less volatile than the overall market. They pay meaningful income. (Do you think it’s a coincidence Warren Buffett’s top-10 stocks for Berkshire Hathaway all pay dividends?)
You have other options . . .
You can secure even more meaningful income in a quality equity investment with “liberty vouchers.”
They’re paying $1,175 every 20 days (on average).
That’s $1,175 in the typical month.