I love a good, motivational quote. You know, the kind you see painted on wooden signs in the home décor stores. I’m not talking about “live, laugh, love”, I’m talking about those quotes that put a little fire in your belly, the quotes that make you think about something like you hadn’t before. When I find a quote that resonates with me, I jot it down and hang it up where I’ll see it every day. Right now, I have a post-it at the bottom of my monitor that says, “uncertainty creates opportunity.” Who said it first? I have no idea but as of today I’m saying it.
There’s some uncertainty when it comes to investing in the market. It’s up and then it’s down and it seems just when things are back on track a single tweet sends things haywire again. Today’s headlines range from “Recession near!” to “Consumer spending at all-time highs.” Talk about mixed signals!
Inverted Yield Curve
In July we saw the Fed cut rates for the first time since 2008 and then in August the spread between the 2-year and the 10-year Treasury note yield inverted for the first time since 2007. When the Fed cuts interest rates investors tend to flock to longer term investments to lock in higher yields. However, as demand increases for these investments so does price. With Treasurys, price and yield move inversely so when the price goes up, yield goes down. In other words, more demand for these investments equals less yield.
The jury is out on whether the Fed will continue to cut rates this year. Fed Chairman Powell called the July cut a “mid-cycle adjustment,” basically saying that they were undoing what they had done in December, which was raise rates.
A normal yield curve is typically a sign of a healthy economy. It slopes upwards from left to right with shorter maturities on the left and longer maturities on the right. This makes sense because if your money is tied up for a longer period, you expect to be compensated for that. When the yield curve flips, investors tend to worry about the state of the economy.
What does it all mean?
History tells us that an inversion of the yield curve typically precedes a recession, but there is no magic formula on how and when this is supposed to happen. So, the million-dollar question – will this inversion of the yield curve lead to a recession? My ten-cent answer; perhaps, but I really don’t know. One thing that’s for certain is that the future is unknowable and if someone tells you they can accurately predict the timing of a recession, run! It’s simply not true. In fact, many economists believe that we don’t even realize we are in a recession until it’s already happened.
If you try to make moves in anticipation of a recession you could do your portfolio more harm than good. If you invested $1,000 in the S&P 500 from 1990-2018 you would now have $13,137, a 9.29% annualized compound return. If you sold out of the market every time there was a concerning headline, like the inverted yield curve for example, you could have missed some of the best days in returns. Missing the 25 best days of that 28-year period would have cost you over 5% in annual returns. Now how do you predict the 25 best days over a 28-year period? You don’t. You stay invested and ride it out because history also tells us that every time there is a recession, there is a bounce back that follows.
Performance of the S&P 500 Index, 1990–2018
In US dollars. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best day(s). Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. “One-Month US T- Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Data is calculated off rounded daily index values.
Recessions happen and volatility in the market is inevitable, these are facts, but if your financial goals remain the same, your portfolio allocation should too. The idea is to plan for uncertainty and to stick to that plan, if all other factors remain the same; and we can help with that. Uncertainty doesn’t have to be scary, sometimes embracing uncertainty can create tremendous opportunity.