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Is This Accurate Indicator Calling for a Recession?

Thankfully, I am not going to explain how the watch is built by detailing the metrics of a yield curve inversion. I am just going to tell you what it means. A normal yield curve will show long-term interest rates or yields higher than the short-term interest rates. The yield curve becomes “inverted” when long-term interest rates have fallen below short-term interest rates. That is what is happening now. What does it mean?


Since 1950, an inverted yield curve has predicted a recession 100% of the time. HOWEVER, the lag time between a recession and the yield curve inverting is approximately 22 months. Bear markets tend to proceed recessions a good percentage of the time. Ok, so that is bad news right? Is the inverted yield curve correct? Are we heading for recession?


Conflicting Messages from the White House


President Trump on one hand wants the Federal Reserve Board to aggressively cut rates as if we are going into a recession. For that to be needed, we would need to see the economy slowing to the point that we are dangerously close to falling into an economic contraction or loss. Then he says this morning, “I don’t think we’re having a recession,” Trump told reporters. “We’re doing tremendously well. Our consumers are rich. I gave a tremendous tax cut and they’re loaded up with money.”


So what is it? The fed needs to aggressively cut rates because of a potential recession or there is no way we are heading for one? 


The Economic Indicators are Showing Just enough Growth but...


The economic indicators are showing no signs of a recession. They are limping along holding steady. They are not growing dramatically as President Trump would have you believe when he is not pushing for an interest rate cut. His record on economic growth is average at best. I do think that he is doing the best he can given what he inherited. Having said all of that, we are probably headed for a recession as the inverted yield curve is signaling based on one fact...The economic cycle.


The Economic Cycle is Alive and Well


In school, you learned that the economy runs in a cycle. Here is what it looks like:


It grows. It slows down. It contracts. It goes into a recession. It starts growing again. The cycle repeats. We are in the slowdown period which historically proceeds an economic contraction and recession.


What that recession looks like is a guess. How do we get out of it? That would be a guess as well. Never in history has the Federal Reserve Board had so little ammo available to fight a recession. The theory of the economic cycle would suggest the high probability of a recession. Beyond that, all bets are off. It could either be a mild one or a severe one. I doubt that President Trump can ward off the economic cycle.


Now your investment result on your retirement could be a bad thing or a good thing. It comes down to how you manage risk. Last week I did a 4 part series on risk. Here are the links to the series – Part I, Part II, Part III, and Part IV. The bottom line is at some point in the future or even now you need to be thinking about your Plan B. Plan A is when the market goes up and Plan B is when the market goes down.


If you want a second opinion on how your are invested, let us take a look in a no cost consultation. Email my assistant, Heather at heather@prudentmoney.com for more information.