Market Health

Yield Indicator Suggests Brewing Recession

The stock rally of early 2019 has offered investors great comfort after a rough 2018.

Last year, we witnessed two back-to-back broad market corrections, as well as the worst December for stocks since 1931.

At the time, I argued that in spite of extreme bearish sentiment, the market was setting up for another strong rebound before the end of this historic bull market.

That prediction has proven correct in recent months.

It began with the strongest January for U.S. stocks in three decades, as well as several weeks of consecutive gains for major stock indexes.

And as of this writing, the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite indexes are all within 3% of new all-time highs.

Even so, investors would do well not to settle into complacency. For in the midst of this rebound, some storm clouds have begun to emerge.

Fed Pumps the Brakes

Back in December, the Federal Reserve anticipated two interest rate hikes for 2019. That’s because, despite the losses in stocks, economic expectations remained positive.

Today, the Fed’s stance is very different.

Earlier this week, the Fed announced it expects no new rate hikes this year.

That’s telling…

It implies that the Fed lacks confidence in the sustainability of our growing economy.

Basically, the economy is too fragile for the Fed to risk further rate hikes at this time.

If there’s any indication of just how fragile the economy is, consider this strangely accurate predictor of doom: the Treasury yield curve, which plots Treasury yields against their maturities.

This chart shows the yield curve today and six months ago…

Back in October, as that year’s second correction was starting to get underway, the yield curve was normal. That is, longer-maturity bonds provided higher yields to investors.

Then something changed…

Shorter-maturity bonds began to see rising yields as longer-maturity bond yields dropped. As a result, something striking occurred.

In March, we witnessed a yield curve inversion. This is when 10-year Treasury bond rates drop below those of 3-month T-bills.

Historically, this inversion has been a harbinger of economic recessions – often within one or two years.

The curve inverted in 2006… two years before the 2008 financial crisis.

It also inverted in 2000… leading into the early aughts’ recession.

And we saw it even further back in 1989… prior to the recession of the early ‘90s.

Now we’re seeing the same signal appear again. And it comes at a time when both U.S. and global economic growth is expected to slow down.

Recently, the International Monetary Fund cut its global growth forecast for 2019 – the fourth cut in nine months.

Last month, the Fed also dropped its U.S. GDP growth forecast for 2019.

And while President Trump has boasted the second-longest economic expansion in U.S. history, he recently suggested that the Fed should reinstate its recession-era program of quantitative easing (read: printing more money) to stimulate economic growth.

Gold’s Warning

We’re also seeing worrying signals from the precious metals market.

Gold and silver have been used as sound money for thousands of years. Today, they’re still regarded as crisis assets used to hedge against economic downturns.

As such, these metals have become an independent gauge for the state of the global economy. So as economic pessimism rises, demand for gold and silver rises.

As you can see, that’s the pattern we’re seeing now.

Gold has gained more than 10% from its 52-week lows set last fall. Silver has followed suit.

So what do these various signs tell us?

A recession may not happen tomorrow or even next week. So investors should remain optimistic, but perhaps cautious as well.

Don’t panic… prepare.

Good investing,

Anthony