Market Commentaries

  • Is the Treasury Yield Curve a Crystal Ball?


    Market Overview


    Sources: Sources for data in tables: Equity Market and Fixed Income returns are from JP Morgan as of 12/07/18. Rates and Economic Calendar Data from Bloomberg as of 12/10/18. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index. Sector performance is measured using GICS methodology.

    Happening Now                   

    Concerns over trade, Brexit, and the first signs of an inverted Treasury yield curve sent equity markets into a vicious tailspin as the S&P 500 Index retreated 4.55%, settling at a level of 2633, while the Russell Midcap Index fell 4.35% last week. Additionally, the Russell 2000 Index, a measure of the Nation’s smallest publicly traded firms, receded by 5.53% over the course of the week. On the international equities front, developed markets lost 2.25%, while emerging market equities gave up 1.33%. Finally, the 10-year U.S. Treasury yield fell substantially, settling at a level of 2.85%, as investors took a risk-off stance and flocked to the perceived safety of U.S. Treasuries.

    Last week started off on a fairly hopeful foot as investors continued to enjoy the residual floor that promising G-20 trade discussions between China and the U.S. provided. However, sentiment quickly reversed course following a string of pro-tariff tweets by President Trump. The ensuing selloff in global equity markets intensified as the first signs of an inverted Treasury yield curve (specifically between the 2 and 5-year Treasury in this case) began to materialize. Many believe that an inverted yield curve (typically between the 3-month and 10-year Treasury) is a foolproof sign of impeding recession. On the other hand, many argue that the shape of the yield curve has been distorted from hefty asset purchases by global central banks in the aftermath of the Great Recession, and such distortion has detracted from the curves predicative power. Let’s momentarily discount this argument, and take a look at the Treasury yield curve through a historical lens.

    Our research into the Treasury yield curve and its reliability as a predictor of near term recession suggests that it has been a dependable leading indicator, not a coincident indicator. In other words, an inverted yield curve typically proceeds an economic recession, not by days or weeks, but by months or years. In fact, on average the yield curve inverted 20 months prior to the start of the last seven recessions, and equity markets averaged a 19% growth rate over that time frame. Investors that fled to safety at the first signs of yield curve inversion might miss out on some of the strongest returns each respective bull market cycle has to offer. According to J.P. Morgan Asset Management, “the average return for the two years preceding a downturn is almost 45%; even for six months preceding, that return averages 14%.”

    To provide another perspective on current recession forecasts, the Cleveland Fed’s recession indicator, which measures the chances of an economic decline over the next 12 months, currently stands at 20%. So, rather than overreact and abandon equity exposure, or capital markets altogether, investors would be wise to revisit the diversification that may, or may not, be in place within their existing portfolios and update (or complete) their longer term financial plans as appropriate. A strategic asset allocation strategy tailored to one’s specific longer term financial plan can help provide comfort to investors during periods of intensified market volatility. If you would like to learn more about how we are helping clients invest dynamically and consistently with their own goals, timeframe and tolerance for risk, please do not hesitate to speak with your Hennion & Walsh Financial Adviser.

    Disclosures: Past performance does not guarantee future results. We have taken this information from sources that we believe to be reliable and accurate. Hennion & Walsh cannot guarantee the accuracy of said information and cannot be held liable. This information is provided for informational purposes only and is not a solicitation to buy or sell any of the asset classes or sectors discussed.

    Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.

    There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.

    The prices of small company and mid cap stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.

    Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.

    Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.

    Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.


    MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.

    MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.

    Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.

    ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.

    ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.

    Investors cannot directly purchase any index.

    LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.

    The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.

    The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.

    DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.

Get Updates: