The headlines in the Wall Street Journal on August 15 are screamers: Stocks, Bonds Flash Warning Signs.
That will get your attention for sure. The Journal has been running articles now over the past several weeks noting that the "yield" on longer term government bonds (ten years in this case) has been approaching, and finally went under, the yield on short term bonds (three month maturity). Normally, investors expect more risk over longer term time frames, thus they pay less for the stated future bond value and the "yield" is higher compared with face value when redeemed. These higher yields (think of it as analogous to interest rates) generally track the longer time frame buyers have to commit, so the 30 year bonds have higher payoffs (per year) than the 10 year bonds, and both are higher than just parking your money in a bond for 3 months.
I realize this is a little nerdy, but please stay with me. If these yields are closer together (compressed) or in extreme cases the long-term bonds offer a lower "yield" than the short term bonds, then something is unusual at least. Investors are paying more, not less, for the face value of these longer term bonds, and that usually means the investors are worried about the future economy. Among other things, they wager that the U.S. Fed will reduce interest rates. All in all, this is a strong historical indicator of fear that the economy will weaken or go into a recession.
The Journal had a nice graphic of the difference of the yield difference between ten year bonds and three month bonds since 1960. In this nearly sixty year period, there have been eight times when the short term bond has yielded higher than the long term bond; buyers were seeking long term security while worrying about a recession. In 1966 or so, there was no recession, but in 1969, 1973, 1979, 1989, 2001, and 2008 there were recessions following this "inversion." This time, in 2019, there was a brief inversion, so the alarm signs are up. Short term, the economy still is strong, unemployment is low, and stock market values still are good. However the stock market is extremely volatile, with large ups and downs on a daily basis. With six of the previous "bond yield inversions" resulting in recessions, the conventional wisdom would suggest concern at a minimum.
Recessions do not immediately occur right away following "inversions." According to the investment company Raymond James, recessions take on average twenty-two months to hit. In late 2008, after the yield inversion occurred, an almost unprecedented international financial contagion crippling recession hit. This was the worst international economic crisis since 1932. Although there are still a few pockets of controversy, it's nearly universally agreed that the extreme stimulus package that George W. Bush's outgoing administration and the incoming Barack Obama administration pulled together forestalled a world-wide financial lock-up and depression.
The current bull market, the longest on record, has been underway now for over 3,800 days, well over ten years. Some argue that the warning signs of yield inversion scream severe problems ahead, especially coupled with the trade-war friction, slowdown in European economies as well as the impending impact of Brexit, the Middle East powder keg, Japanese-Korean friction exacerbating historical enmity, North Korean nuclear buildup, and Trumpian pressure on traditional US allies including the NATO bloc.
Another economic viewpoint posits on the growing middle class in China, India, and parts of Africa. The current trends indicate that both China and India will have middle classes of nearly 5oo million citizens each within a decade or at most two. Africa should add 200 million people to this economic class. This would increase the economic middle class world wide in these three areas alone by somewhere between 500 million to 600 million people by the year 2040. It's hard to imagine an economic hole that's too deep with all this purchasing power coming into play.
So where does this leave us now? Nobody knows for sure. But these are some unsettling developments that are storm clouds at a minimum. Trade wars and tariffs are bad for economies in general, as they increase costs and impede the flow of goods and services. Countries and corporations tend to be more cautions with long-term investments. Civil wars, domestic violence, and the resulting demographic migrations are difficult as people move to safer areas. Commerce is affected in addition to increased human misery. Resentment by people in the areas receiving populations of large numbers of people "not like them" rises. Nationalism and protectionism are tied to these pressures and often leads to extremist sentiments. A major international war is almost unthinkable in the nuclear age.
Tied to the economic red flags mentioned above, it goes without saying that the personal style of President Trump evokes strong reactions by both supporters and detractors. One thing for sure, the country is increasingly polarized. What will happen? As Mr. Trump often says, "We'll have to wait and see."
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