The Name Of The Game Is Bond…Treasury Bond
Questions about where the economy is heading? The name is Treasury bond (not James Bond).
Back in 1993, Clinton political adviser James Carville said:
“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”
President Bill Clinton was more profane:
“You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of [expletive deleted] bond traders?”
Fast forward to today and all eyes are once again on the bond market as a gauge of economic health.
Financial writers lately are devoting a lot of ink and computer pixels to the hot topic of the inverted yield curve as a leading indicator of recession. Let’s separate the hype from reality, so you can make more informed investing decisions.
As I wrote in the June 17 Mind Over Markets, when short-term interest rates are higher than long-term interest rates, it has been a reliable red flag of recession in the following 12-18 months. With the yield spread between 10-year Treasury bonds and three-month Treasury bills inverting recently, recession fears are mounting.
If they sense a recession is on the way, many investors will start to invest in long-term U.S. Treasury bonds, because they’re pessimistic about the short term. Bond prices and yields move in opposite directions.
Keep in mind, though, that there’s usually a lag time of at least several months between the occurrence of an inverted yield curve and an actual recession. What’s more, we’ve witnessed false alarms in the past.
I’d be more worried about a looming recession if other indicators also heralded a recession. Consider credit spreads, defined as the difference between yields on corporate bonds and Treasury bonds. Credit spreads currently are modestly below the long-term average, which means the economy isn’t experiencing a significant tightening in financial conditions.
Returns for fixed-income investors have been robust year-to-date. Every fixed-income asset class, from the safest to the riskiest, has generated gains. Utilities and real estate, in particular, have been on a tear.
Year to date, the benchmark exchange-traded funds (ETFs) Real Estate Select Sector SPDR Fund (XLRE) and Utilities Select Sector SPDR Fund (XLU) have returned 23.6% and 15.3%, respectively, compared to 16.3% for the SPDR S&P 500 ETF (SPY).
You can thank the sharp drop in long-term interest rates over the past six months. With bond yields at low levels, the healthy yields of dividend-paying stocks offer attractive alternatives to bonds for conservative, income investors. The returns in defensive income-oriented sectors should stay positive for the rest of 2019, albeit at a lower level than the first half of the year.
The big question right now is whether the economy is simply cooling, or about to lapse into full-blown recession. Amid today’s mixed bag of economic conditions, the momentum still resides with the stock market bulls.
Economic growth is on track, unemployment is low, inflation is under control, and consumer spending remains strong. Wild cards include trade war, geopolitical tensions, political instability in the U.S., and the fact that we’re in the late stage of an economic expansion.
Second-guessing the Fed…
As of this writing on Wednesday morning, the Federal Reserve’s Federal Open Market Committee (FOMC) was wrapping-up its two-day meeting, with a policy statement scheduled for the late afternoon.
The betting on Wall Street is that the Fed will leave rates unchanged, with Fed Chair Jerome Powell laying the rhetorical groundwork for a rate cut later this year. The minutes of regularly scheduled meetings are released three weeks after the date of the policy decision, at which time we’ll get further clues as to the Fed’s intentions.
In a survey conducted earlier this week by the Wall Street Journal, nearly 40% of economists expect the Fed to cut rates next month. The FOMC meets again July 30-31.
My informed hunch? Those who expect another rate cut will be disappointed. The Fed is willing to remain neutral but after a decade of loose monetary policy, the central bank probably views further monetary easing as irresponsible. Accordingly, stocks could be poised for a sell-off if the Fed doesn’t meet Wall Street’s excessive hopes.
What should you do in this volatile investment climate? Seek defensive growth. Stick to companies with strong balance sheets, growing earnings, and quality products that address long-term human needs. Over the long haul, markets exhibit an upward bias and the cream rises to the top. But for the short term, expect more turbulence and down days. Look for value and safety; gravitate to defensive sectors such as utilities, real estate and consumer staples.
With the Treasury yield curve inverted, you should consider what’s known as “barbells,” holding both short-term and intermediate-term bonds in the bond sleeve of your portfolio.
The barbell term stems from the fact that this allocation resembles a barbell, heavily weighted at both ends and with nothing in between. The short-term investments provide liquidity and flexibility to reinvest if rates rise; the intermediate-term bonds confer steady income if yields move down.
Portfolio allocations that make sense now: 50% stocks, 25% hedges (such as gold and other precious metals), 15% cash, and 10% bonds.
Baseball legend Willie Keeler had a motto: “Keep your eye on the ball and hit ’em where they ain’t.” That advice also can be applied to investing.
Big investment themes are all fine and good, but it’s more difficult to profit from them when they’re being talked to death on CNBC. That’s why, in their respective trading services, the experts at Investing Daily look for under-the-radar opportunities.
Mounting risks such as tit-for-tat tariffs have left investors stirred, but not completely shaken. Keep reading Mind Over Markets for big picture guidance and turn to our chief investment strategists for the specific picks that help you build wealth over the long haul.
Your comments and questions are welcome. You can reach me at: email@example.com
John Persinos is the managing editor of Investing Daily.