Yield Curve Inverting

[Cigarbutt]

...

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Back to investing.

 

Cigarbutt,

 

Somehow I'll argue, that the bullet #1 in the Youtube video : - "Slight nose up attitude" - certainly has merit in the current investment environment, -but not exactly meant the way mentioned in the video ... - more conceptually meant with reference to Icarus, Hubris & Nemesis. [ ; - ) ]

 

- - - o 0 o - - -

 

Today, I've been bear hugging my NVO dividends just received.

 

- - - o 0 o - - -

 

On a more serious note: In short, I share Spekulatius' view, expressed above. Likely rough times ahead for us. Personally, I just hope that we this year get at least some satisfactory clarity on the situation going forward with regard to Brexit & ongoing trade disputes. This may however still be too much to ask or hope for.

Hi John,

FWIW, last April 7, 2018, after reading a post of yours and trying to deal with investment-related persisting cognitive dissonance, I wrote a poem (which nobody will get to see) with the following title: On Wax and Wings and it referred to Icarus (the myth and the Bruegel painting).

https://en.wikipedia.org/wiki/Landscape_with_the_Fall_of_Icarus

http://www.cornerofberkshireandfairfax.ca/forum/strategies/getting-gains-in-a-bull-market/msg329541/#msg329541

-----)back to the quantitative side of investing.

 

[Spekulatius]

While watching these shows in awe, I always wonder what the downside risks are.

 

http://www.defenseworld.net/uploads//news/big/mirage-v__1476787129.jpg

 

Note that the pilot (= Banker in our weird world) successfully ejects and presumably lands safely using his golden parachute. As for the innocent bystanders, we do not know.

 

I may be pushing this analogy too far now.

[Spekulatius]

Yields are getting horizontal and who knows what that means?

Bias: in another life a flatline meant efforts for resuscitation and it seems that the FED may be getting ready to do just that as they recently surveyed primary dealers on how to fine-tune the management of rates.

 

A lingering thought is that successful resuscitation is generally unlikely and is inversely related to the length of time spent attempting resuscitation. At least, that's what Wikipedia says.

 

I personally can’t tell what is a symptom and what is the disease, but I tend to think of inverting interest rate as a symptom.

 

Just my opinion, but every time, investors put their hope into Fed, they tend to get disappointed. I suspect the market will take a real dump, if indeed the Fed starts to lower rates.

 

I think it can be be both right? At first it's a symptom - it's markets being concerned about future growth/inflation and predicting a rate cut; however, it can also become self-fulfilling and contribute to the slowdown because the inversion strangles credit supply further slowing the economy

 

Reflexivity.  In this case, there are definitely fundamental issues regardless of expectations. Rising rates would have a serious impact, no matter how they do it, the only question is how bad.  The method the Fed uses makes things worse, because, well, they are clueless as the past few months have shown.

 

The big unknown here is not the Fed, it's Trump.  He called an emergency on the wall. He just nominated someone to the Fed that no doubt he believes will support his views. What else is he willing to do for us to get a happy dead cat bounce?  That's my bet, it's not going straight down from here.  We will have fun first.

 

Agreed. It's never straight down. There are always bounces along the way until the buy-the-dip mentality is sufficiently beaten to death.

 

It's why I didn't sell/short on the way down in December, but was selling/shorting/buying bonds after the incredible bounce in January.

 

This was an opportunity to reduce risk after markets have confirmed the bear market. Not an opportunity to buy the dip.

 

Late stage bull markets can be a lot of fun:

[shalab]

yield curve inverted again:

 

https://www.bing.com/videos/search?q=inverted+yield+curve&docid=13840512517203&mid=9937A21325DBF8F47CD09937A21325DBF8F47CD0&view=detail&FORM=VIRE

 

[shalab]

Parsad says USA consumer prices will go up if USA workers take home more money this year. However all data is pointing to the other direction, i.e., prices going down.

 

The USA saving rate has been higher than average compared to the recent past, where savings rate on disposable income is at 7-8% of GDP. This is excluding contributions to 401(k), ESPP, IRA/Roth-IRA, HSA etc. which can soak anywhere between 0 - 35% of income.

 

https://www.reuters.com/article/usa-bonds-tips-umich-idUSL2N23L0MC

https://tradingeconomics.com/united-states/producer-prices

 

Barrons ran an article saying rate cuts are needed and more importantly some QE may be needed by year end:

 

https://www.barrons.com/articles/the-rate-cut-the-economy-doesnt-need-but-the-markets-do-51560557553?mod=hp_DAY_1

https://www.barrons.com/articles/the-fed-may-have-shrunk-its-balance-sheet-too-quickly-51560504607?mod=past_editions

 

 

Meanwhile, the person that has invested with Parsad is betting on a deflation. (FRFHF)

CPI-linked derivative contracts

The company has entered into derivative contracts referenced to consumer price indexes (“CPI”) in the geographic regions in which it operates that

serve as an economic hedge against the potential adverse financial impact on the company of decreasing price levels. At March 31, 2019 the company

held CPI-linked derivative contracts with a fair value of $16.2 (December 31, 2018 - $24.9), notional amount of $113.6 billion (December 31, 2018 -

$114.4 billion) and weighted average term until expiry of 3.4 years (December 31, 2018 - 3.6 years).

The company’s CPI-linked derivative contracts produced net unrealized losses of $4.3 in the first quarter of 2019 (2018 - $20.2). Net unrealized gains

(losses) on CPI-linked derivative contracts typically reflect the market's expectation of decreases (increases) in the values of the CPI indexes underlying

those contracts at their respective maturities (the contracts are structured to benefit the company during periods of decreasing CPI index values).

[Cigarbutt]

Parsad says USA consumer prices will go up if USA workers take home more money this year. However all data is pointing to the other direction, i.e., prices going down.

 

The USA saving rate has been higher than average compared to the recent past, where savings rate on disposable income is at 7-8% of GDP. This is excluding contributions to 401(k), ESPP, IRA/Roth-IRA, HSA etc. which can soak anywhere between 0 - 35% of income.

 

https://www.reuters.com/article/usa-bonds-tips-umich-idUSL2N23L0MC

https://tradingeconomics.com/united-states/producer-prices

 

Barrons ran an article saying rate cuts are needed and more importantly some QE may be needed by year end:

 

https://www.barrons.com/articles/the-rate-cut-the-economy-doesnt-need-but-the-markets-do-51560557553?mod=hp_DAY_1

https://www.barrons.com/articles/the-fed-may-have-shrunk-its-balance-sheet-too-quickly-51560504607?mod=past_editions

 

 

Meanwhile, the person that has invested with Parsad is betting on a deflation. (FRFHF)

CPI-linked derivative contracts

The company has entered into derivative contracts referenced to consumer price indexes (“CPI”) in the geographic regions in which it operates that

serve as an economic hedge against the potential adverse financial impact on the company of decreasing price levels. At March 31, 2019 the company

held CPI-linked derivative contracts with a fair value of $16.2 (December 31, 2018 - $24.9), notional amount of $113.6 billion (December 31, 2018 -

$114.4 billion) and weighted average term until expiry of 3.4 years (December 31, 2018 - 3.6 years).

The company’s CPI-linked derivative contracts produced net unrealized losses of $4.3 in the first quarter of 2019 (2018 - $20.2). Net unrealized gains

(losses) on CPI-linked derivative contracts typically reflect the market's expectation of decreases (increases) in the values of the CPI indexes underlying

those contracts at their respective maturities (the contracts are structured to benefit the company during periods of decreasing CPI index values).

Shalab,

It seems that we disagree about where we're going although it will have to be, in the end, the same destination.

"However all data is pointing to the other direction, i.e., prices going down."

 

This yield inversion talk is getting confusing but one of the most significant and fundamental measures I've been following agrees that asset prices may have entered a deflationary phase: the Tooth Fairy payout.

https://www.prnewswire.com/news-releases/tooth-fairy-payouts-plunge-for-second-consecutive-year-300798356.html

I've been able to match the Tooth Fairy payout until 2012 and then it seems that the payout has been looking for a reversion to the mean.

You will also notice that the US regions that have suffered from globalization have shown their resentment through lower payouts.

 

 

 

[shalab]

I stand corrected - I should have said the prices aren't increasing as fast as the Fed is expecting. Prices are definitely going up but below the Fed target rate. Asset prices (houses) have come down in the last year.

 

Parsad says USA consumer prices will go up if USA workers take home more money this year. However all data is pointing to the other direction, i.e., prices going down.

 

The USA saving rate has been higher than average compared to the recent past, where savings rate on disposable income is at 7-8% of GDP. This is excluding contributions to 401(k), ESPP, IRA/Roth-IRA, HSA etc. which can soak anywhere between 0 - 35% of income.

 

https://www.reuters.com/article/usa-bonds-tips-umich-idUSL2N23L0MC

https://tradingeconomics.com/united-states/producer-prices

 

Barrons ran an article saying rate cuts are needed and more importantly some QE may be needed by year end:

 

https://www.barrons.com/articles/the-rate-cut-the-economy-doesnt-need-but-the-markets-do-51560557553?mod=hp_DAY_1

https://www.barrons.com/articles/the-fed-may-have-shrunk-its-balance-sheet-too-quickly-51560504607?mod=past_editions

 

 

Meanwhile, the person that has invested with Parsad is betting on a deflation. (FRFHF)

CPI-linked derivative contracts

The company has entered into derivative contracts referenced to consumer price indexes (“CPI”) in the geographic regions in which it operates that

serve as an economic hedge against the potential adverse financial impact on the company of decreasing price levels. At March 31, 2019 the company

held CPI-linked derivative contracts with a fair value of $16.2 (December 31, 2018 - $24.9), notional amount of $113.6 billion (December 31, 2018 -

$114.4 billion) and weighted average term until expiry of 3.4 years (December 31, 2018 - 3.6 years).

The company’s CPI-linked derivative contracts produced net unrealized losses of $4.3 in the first quarter of 2019 (2018 - $20.2). Net unrealized gains

(losses) on CPI-linked derivative contracts typically reflect the market's expectation of decreases (increases) in the values of the CPI indexes underlying

those contracts at their respective maturities (the contracts are structured to benefit the company during periods of decreasing CPI index values).

Shalab,

It seems that we disagree about where we're going although it will have to be, in the end, the same destination.

"However all data is pointing to the other direction, i.e., prices going down."

 

This yield inversion talk is getting confusing but one of the most significant and fundamental measures I've been following agrees that asset prices may have entered a deflationary phase: the Tooth Fairy payout.

https://www.prnewswire.com/news-releases/tooth-fairy-payouts-plunge-for-second-consecutive-year-300798356.html

I've been able to match the Tooth Fairy payout until 2012 and then it seems that the payout has been looking for a reversion to the mean.

You will also notice that the US regions that have suffered from globalization have shown their resentment through lower payouts.

[Broeb22]

It's kind of odd that the inverted yield curve in mid-2019 was followed by a recession, which technically makes the indicator correct again. When the recession is caused by a virus and not general economic conditions, that feels more flukey too me. Or does the yield curve predict recessions driven by famine and war too?

[TwoCitiesCapital]

It's kind of odd that the inverted yield curve in mid-2019 was followed by a recession, which technically makes the indicator correct again. When the recession is caused by a virus and not general economic conditions, that feels more flukey too me. Or does the yield curve predict recessions driven by famine and war too?

 

You could make the argument that we were heading into a recession regardless.

 

PMIs had been sub-50 globally for some time. Manufacturing had already been in a multi-month contraction. Who is to say that had covid-19 never occurred, that we wouldn't have found ourselves in a recession by this summer anyways?

 

There's always a catalyst. Covid-19 is no different. Something always happens that we can blame the recession on, but it's the environment that makes us vulnerable to that shock. An inverted yield curve, declining PMIs, manufacturing weakness, global trade thrown into disarray/uncertainty, make us vulnerable to whatever shock comes - whether that be covid, or s string of corporate defaults, or a currency shock, etc. The vulnerability makes that a recession versus a wall of worry that we climb over.

[COBFInfinity]

It's kind of odd that the inverted yield curve in mid-2019 was followed by a recession, which technically makes the indicator correct again. When the recession is caused by a virus and not general economic conditions, that feels more flukey too me. Or does the yield curve predict recessions driven by famine and war too?

 

You could make the argument that we were heading into a recession regardless.

 

PMIs had been sub-50 globally for some time. Manufacturing had already been in a multi-month contraction. Who is to say that had covid-19 never occurred, that we wouldn't have found ourselves in a recession by this summer anyways?

 

There's always a catalyst. Covid-19 is no different. Something always happens that we can blame the recession on, but it's the environment that makes us vulnerable to that shock. An inverted yield curve, declining PMIs, manufacturing weakness, global trade thrown into disarray/uncertainty, make us vulnerable to whatever shock comes - whether that be covid, or s string of corporate defaults, or a currency shock, etc. The vulnerability makes that a recession versus a wall of worry that we climb over.

 

Seems like a bogus argument for 2020. The economy could have been at max strength, but still would have been hammered due to COVID shutdowns. We can all play the guessing game of whether a U.S. recession would have rolled in by now anyway, but the idea that the economy was fragile and COVID was just the tipping point? That's implausible. Simple way to look at it is that a huge number of countries had a COVID recession - were they all going to have a recession anyway? Clearly not.

[TwoCitiesCapital]

It's kind of odd that the inverted yield curve in mid-2019 was followed by a recession, which technically makes the indicator correct again. When the recession is caused by a virus and not general economic conditions, that feels more flukey too me. Or does the yield curve predict recessions driven by famine and war too?

 

You could make the argument that we were heading into a recession regardless.

 

PMIs had been sub-50 globally for some time. Manufacturing had already been in a multi-month contraction. Who is to say that had covid-19 never occurred, that we wouldn't have found ourselves in a recession by this summer anyways?

 

There's always a catalyst. Covid-19 is no different. Something always happens that we can blame the recession on, but it's the environment that makes us vulnerable to that shock. An inverted yield curve, declining PMIs, manufacturing weakness, global trade thrown into disarray/uncertainty, make us vulnerable to whatever shock comes - whether that be covid, or s string of corporate defaults, or a currency shock, etc. The vulnerability makes that a recession versus a wall of worry that we climb over.

 

Seems like a bogus argument for 2020. The economy could have been at max strength, but still would have been hammered due to COVID shutdowns. We can all play the guessing game of whether a U.S. recession would have rolled in by now anyway, but the idea that the economy was fragile and COVID was just the tipping point? That's implausible. Simple way to look at it is that a huge number of countries had a COVID recession - were they all going to have a recession anyway? Clearly not.

 

My point isn't to say that Covid wouldn't caused a recession.

 

My point was to say that maybe a recession was going to happen even without Covid and we would've just blamed it on some other catalyst. We always look to catalysts, but what matters is the environment that allows us to be vulnerable to that catalyst.

 

What was the catalyst for 2008? Real estate prices falling. But that wouldn't have been a huge thing in and of itself. But it was paired with an inverted yield curve, weakening growth, over leveraged consumers, and severely under capitalized banks (relative to the risk they were taking). So what was the real cause of the recession? Home prices falling? Failing banks? Or the environment of all of them together making us so fragile we couldn't handle the falling home prices, or other economic occurrences, when they happened?

 

We were already visibly seeing signs of a recession. I didn't foresee covid. Covid isn't why I was 50% cash. I was 50% cash because I was fairly certain the odds of a recession were high given what the economic data was showing in September of 2019. Didn't know what would cause the tip, just that it appeared we were approaching a tipping point and sold.

 

Sure, blame the recession on Covid. It certainly made it worse, but I'm of the mindset it was happening anyways as demonstrated by my positioning in late 2019.

[COBFInfinity]

My view is simple whether you are using a yield curve model or anything else to try to forecast the economy - you probably need to throw out the 2020 data. My other view is that the economy and markets are pretty unpredictable, so you shouldn't rely on those models too much anyway. I am of the view that U.S. stocks are probably higher today than they would have been without COVID. I think that is fundamentally insane, yet here we are.

[Broeb22]

You can really twist yourself into knots with the counterfactuals of that statement. If COVID didn’t happen, Trump would have been significantly more likely to win as an incumbent with a strong economy, and would the prospect of his second term have been good or bad?

 

I generally would agree that if we continued to muddle through that stocks probably wouldn’t be up nearly 20% and the Nasdaq wouldn’t be up whatever it’s up.

[dpetrescu]

The 2019 inverted yield curve was an interesting one. I remember seeing all the interviews with Harvey in which he shows the amazing track record over decades, the whole time thinking, could this be the most predicted recession in modern history? Would it have been a case of remarkable inevitability, a Mandelbrot illusion of a pattern, or maybe because of the fast it was so predictable - because everyone was familiar within it would play out in a different way?

 

And then Coronavirus happened. I guess we will never know. At least until the next time it inverts. Maybe by then everyone will have doubled their investments enough times they won’t want to believe it.

[Spekulatius]

Interesting enough, interest rates have been moving up. We are basically back to where we were late February/ early March.

[mattee2264]

 

Does the yield curve have the same predictive power when short term interest rates are manipulated by central banks and probably long term interest rates will be as well as they start to rise?

 

 

[Cigarbutt]

The 2019 inverted yield curve was an interesting one. I remember seeing all the interviews with Harvey in which he shows the amazing track record over decades, the whole time thinking, could this be the most predicted recession in modern history? Would it have been a case of remarkable inevitability, a Mandelbrot illusion of a pattern, or maybe because of the fast it was so predictable - because everyone was familiar within it would play out in a different way?

And then Coronavirus happened. I guess we will never know. At least until the next time it inverts. Maybe by then everyone will have doubled their investments enough times they won’t want to believe it.

Disclosure #1: stock picking is the way to go, if you can. So, this is likely a waste of time.

Disclosure #2: i've been 'communicating' with various 'friends' and acquaintances for holiday greetings and when the discussion superficially touches investments, i feel relatively stupid and got to watch out for envy and maybe accept the real possibility of stupidity (relative or absolute).

-----

I never thought Mr. Mandelbrot would be mentioned here and there you go. When i graduated in 1996 (mostly science-related), i decided to 'manage' household investments and had to learn what an asset was. For a year or two, went through 'economics' and came across Mr. Mandelbrot's writings. Fascinating. He was a remarkable individual, perhaps from the same multi-dimensional mold as Mr. Charlie Munger. Three things stuck from the unique thinker. First, contrarianism. From the source: "As I allowed myself to drift, I soon came to view the normal unpredictability in life as contributing layers or strata of experience that are valuable, demand no apology, and add up to a unique combination." Second, conceptual tools when i met annual reports from Mr. Prem Watsa somewhere in early 1997. That's when 'value investing' came to view. Understanding FFH then meant to understand the value of reserves (wild euphemism in this case) and i realized that not many people really looked at reserve triangles. Mr. Mandelbrot's ideas of mixing deterministic and stochastic models were very helpful then, and periodically after. Third, how to deal with physics envy in softer fields or how to mix chaos to models (tensile strength and fractures, weather 'prediction', inverting yield curves etc).

Of course, the inverting yield curves and ultra-low interest rates are saying something. And the wildness of the message lies in wait. It feels like the whole covid thing was simply an interlude.

-----

Still, by using a variety of historical measures, this market (valuation, spreads etc) is the most optimistic it has ever been. Of course, the market could be right and it's really a great time to be alive.

 

[TwoCitiesCapital]

The 2019 inverted yield curve was an interesting one. I remember seeing all the interviews with Harvey in which he shows the amazing track record over decades, the whole time thinking, could this be the most predicted recession in modern history? Would it have been a case of remarkable inevitability, a Mandelbrot illusion of a pattern, or maybe because of the fast it was so predictable - because everyone was familiar within it would play out in a different way?

And then Coronavirus happened. I guess we will never know. At least until the next time it inverts. Maybe by then everyone will have doubled their investments enough times they won’t want to believe it.

Disclosure #1: stock picking is the way to go, if you can. So, this is likely a waste of time.

Disclosure #2: i've been 'communicating' with various 'friends' and acquaintances for holiday greetings and when the discussion superficially touches investments, i feel relatively stupid and got to watch out for envy and maybe accept the real possibility of stupidity (relative or absolute).

-----

I never thought Mr. Mandelbrot would be mentioned here and there you go. When i graduated in 1996 (mostly science-related), i decided to 'manage' household investments and had to learn what an asset was. For a year or two, went through 'economics' and came across Mr. Mandelbrot's writings. Fascinating. He was a remarkable individual, perhaps from the same multi-dimensional mold as Mr. Charlie Munger. Three things stuck from the unique thinker. First, contrarianism. From the source: "As I allowed myself to drift, I soon came to view the normal unpredictability in life as contributing layers or strata of experience that are valuable, demand no apology, and add up to a unique combination." Second, conceptual tools when i met annual reports from Mr. Prem Watsa somewhere in early 1997. That's when 'value investing' came to view. Understanding FFH then meant to understand the value of reserves (wild euphemism in this case) and i realized that not many people really looked at reserve triangles. Mr. Mandelbrot's ideas of mixing deterministic and stochastic models were very helpful then, and periodically after. Third, how to deal with physics envy in softer fields or how to mix chaos to models (tensile strength and fractures, weather 'prediction', inverting yield curves etc).

Of course, the inverting yield curves and ultra-low interest rates are saying something. And the wildness of the message lies in wait. It feels like the whole covid thing was simply an interlude.

-----

Still, by using a variety of historical measures, this market (valuation, spreads etc) is the most optimistic it has ever been. Of course, the market could be right and it's really a great time to be alive.

 

The "market" can't be right because there are multiple markets predicting different outcomes.

 

US Debt markets? Pricing in incredibly low growth and low inflation for the foreseeable future.

 

US Equities? Incredibly optimistic about US growth

 

Markets can't be right when they're predicting the opposite outcomes.