There are, however, several shapes a yield curve can take. Here are some of the most important:
As seen above, this scenario is when investors are anticipating the economy to expand at normal growth rates without significant inflation or capital availability issues. This defines a period of economic and stock market expansion and good news for investors and economists. The yield curve slopes gently upward as bond (longer term treasuries) investors demand more of a return to counterbalance interest rate risk in the future.
This results when we have a greater-than-normal gap between the shorter and longer term treasuries as we see here in April of 1992. This marks the beginning of an economic expansion shortly after a recession. By 1993, the GDP was expanding by 3% per year and by the following year short-term interest rates had increased by 2 percentage points. That’s why investors were demanding greater long-term returns. Those investors who used this curve to increase their stock holdings were rewarded with a 20% return over the next two years (Russell 3000).
This occurs when long-term yields fall below shorter-term yields. Long term investors are betting that the economy will decline in the future. An inverted yield curve has predicted a worsening economy in the future 5 out of 6 times since 1970. The NY Federal Reserve regards this yield shape to be predictive of recessions two to six quarters ahead. Stock investors should take this situation seriously. These curves are rare but are almost always followed by economic slowdown or even recession.
Flat or Humped Curve:
In the case of a flat curve, all maturities have similar yields. For humped curves, short and long term maturities are the same while intermediate maturities are higher. It is important to note, that for a yield curve to become inverted, it must pass through this phase first. Now, not all flat or humped curves become inverted but most are predictive of economic slowdown and lower interest rates. Like inverted curves, it is a red flag for stock investors.
Recent Yield Curve:
How would you classify this yield curve? If you read it (as I do) as a steep yield curve than this is one indicator of economic expansion after a recession. This is another reason I have been defining my market outlook as moderately bullish.
Here is a free website to access the current yield curve:
1- Last weeks interview with Kerry Lutz of the Financial Survival Radio Network has been uploaded to YouTube:
2- This Saturday, April 14th:
I will be the keynote speaker for the American Association of Individual Investors/Atlanta Chapter at the Cobb Galleria. The meeting runs from 10AM to 1PM EST and everyone is invited. The club charges $10 for pre-registration and $15 at the door. Here is the link to register:
This week’s reports were mixed to negative but not game-changing:
In the minutes of its march policy committee meeting the Fed seemed less inclined to institute another round of bond purchases to loosen credit
The Fed re-iterated its intention to keep its target interest rate near zero until late 2014
There was a slight rise in the broad manufacturing index in March
The Commerce Dept reported that February’s rise in overall factory orders more than made up for January’s decline
The ISM manufacturing index came in at 56, slightly below the expected 57
Although construction remains relatively depressed it is still ahead of its pace of a year ago
On Friday, a weaker-than-expected jobs report came in at 120,000 new jobs added, less than expected as the unemployment rate dropped to 8.2%. This news was NOT a game-changer because:
Unseasonably warm weather in December through March resulted in fewer layoffs and therefore fewer hires in March
60% of all industries are actually adding jobs
The trend is positive as the labor force has expanded an average of 273,000 jobs/month over the past 3 months
For the week, the S&P 500 fell by 0.7% for a year-to-date return of 12%.
IBD: Market in correction
BCI: Moderately bullish selling an equal number of ITM and OTM strikes
Happy holidays to all our members and your families,
Alan, the BCI team and our families ([email protected])