The market’s fear index, the VIX, exploded on Monday, rising nearly 17% and closing at 21.07. Now, the more investors experience panic and fear– the higher the VIX goes. And according to this sentiment indicator, yesterday was the sixth scariest close of the year.
But do you know what else was alarming?
Global bond yields are at the lowest levels in over 100 years. And yesterday, U.S. Treasury yields took another bath– as the yield curve flattened to its lowest levels since 2007. The 30-year treasury bond yield is also nearing all-time lows.
It’s this type of action that has some economists believing we are on the brink of a recession.
Do they have a reason to be concerned?
Is a “buy the dip” moment on the horizon?
I’ll answer those questions and more in a little bit.
But before I do, I should say this: don’t worry about what you can’t control and focus on what you can.
If you learn the skills to make money when stocks are trading sideways, bearish, or bullish– you don’t panic– you just adjust your strategy to fit that market condition.
U.S. Treasury yields collapsed yesterday… and stocks were weak yet again, as there are concerns about the U.S. – China trade war and global political tensions. That said, we’ve seen a lot of traders bid up bonds in an attempt to protect their portfolios.
What that actually signals to us is that traders might actually be afraid of a stock market crash.
You see, the yield curve is sounding a warning siren… the loudest siren the markets have heard since 2007 – prior to the global financial crisis.
Here’s what I’m talking about…
Source: New York Fed
If you look at the chart above (keep in mind this data is reported monthly), as of August 2, you’ll notice that the Treasury Spread between the 10 Year Treasury Bond and the 3-Month Treasury Bill is negative.
In other words, we have an inverted yield curve. This occurs when short-term Treasury bond yields are higher than long-term ones, exactly like we’re seeing now.
If you think about it, it doesn’t make a whole lot of sense… typically you get better yields (higher interest rates) if you’re buying longer-term bonds due to the added risk.
The way an inverted yield curve works is that investors and traders expect lower interest rates in the future (they’re expecting the Fed to cut rates and have concerns about economic growth) than they are anticipating in the near future (say 3 months from now).
As traders’ expectations for economic growth to slow down, bonds become more attractive because they act as a hedge to portfolios. In turn, this actually drives yields lower.
Typically, we see an inverted yield curve prior to recessions…
Right now we’re seeing the 10-Year Treasury Yield at 1.639% (as it collapsed yesterday)… and the 3-Month Treasury Yield at 1.989%.
Just take a look at the price action in the 3-Month U.S. Treasury Yield this year so far…
… now compare that to 2007 (as we were heading into the financial crisis)…
Check out the 10-Year Treasury Yield so far this year…
… and back in 2007.
We’re seeing the similar action in both the 3-Month and 10-Year yields right now as we saw back in 2007 right before the last financial crisis.
It’s not just a one-off, we typically see short-term bond yields climb above longer-term yields ahead of economic downturns…
… if you refer back to this chart… you’ll notice that every time the 3-Month and 10-Year Treasury Yield spread broke below 0… a recession followed.
If you look in the chart above (the vertical lines signal the recessions).
- February 2006 – We saw the yield curve inverted for the first time… thereafter, the global financial crisis followed in 2007 – 2009.
- July 2000 – The yield curve inverted for the first time… and we saw the internet bubble pop and a recession.
- May 1989 – Yield curve was yet again inverted prior to the 8-month long recession in the U.S. from 1990 to 1991.
You get the idea.
However, you might be wondering, Jeff if you’ve seen this signal before, does that mean you’re piled in on the short side?
Well, not quite yet. You see, the move actually takes a bit of time to materialize.
You see, short-term yields can rise above longer-term yields well before the economy shows signs of slowing down… so before I place large bets on a potential stock market crash, I’m going to remain patient and continue monitoring the situation.
Right now, some exchange-traded funds (ETFs) I’ll be keeping an eye on with yields include the SPDR S&P 500 ETF (SPY), PowerShares QQQ Trust (QQQ), iShares 20+Year Treasury Bond ETF (TLT), and the VIX.
Here are some charts I’m watching right now…
I’m going to remain patient and wait for a clear signal before I get into any trades. For the most part, I’ll be looking for my money pattern and keeping an eye on key levels… and I’m looking for fast triple-digit returns…
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