|10-Year Treasury yield was at 2.02% and finished August at 1.50%|
Wall Street once again saw major volatility throughout most of August, much of it attributed to more back-and-forth sparring in the Trump-China trade war. More significantly, the US yield curve became fully inverted, a development seen as the strongest warning signal yet of an impending recession and major market correction. The inversion occurred when the yield on the 10-Year Treasury fell below the 2-Year note, and the 30-Year Bond closed below 2% for the first time ever.* The 10-Year Yield was already lower than the Federal Reserve’s benchmark short-term interest rate despite the Fed lowering rates to 2.25% at its July meeting.
When a yield curve inverts, it’s essentially because investors have little confidence in the long-term economy. That’s why an inverted yield curve is said to be one of the most accurate indicators of a coming recession—and history bears out that accuracy. According to studies, an inverted yield curve has preceded every domestic recession since 1955.** Experts arguing that this time will be different maintain that this inverted yield curve is not really being caused by a projected major slowdown in growth for the US economy, but by the global economic situation.
While there is some merit to that argument, it overlooks a key point, which is that an inverted yield curve isn’t always just a symptom of recession; sometimes it’s a primary cause. Banks and other lending institutions suffer real fiscal consequences when the yield curve inverts. With long-term interest rates lower than short-term rates, banks have to pay depositors more than they get back from borrowers. They lose their financial incentive to lend, which affects home sales, car sales, business start-ups and a host of other areas crucial to economic growth.
With all of this in mind, I believe we’re in a “sweet spot” now for investors who haven’t yet reduced their stock market risk. The market is still holding close to an all-time high, so you still have time to reposition assets accordingly. As I noted last month, the current environment also
creates a good opportunity for Income Specialists to demonstrate why investing-for-income is a sound strategy regardless of market conditions. While overall low interest rates do make it challenging to get good competitive yields, you can be sure that I and other advisors who specialize in active management are making the strategic adjustments necessary to meet that challenge on behalf of our clients.
When managing your portfolio at SIS, we look for one of four possible “enhancement” trades while reviewing securities and possible transactions. Income generation is our primary goal for our clients, and we consider the following four portfolio enhancements before transacting: current yield, yield to worst (minimum projected annualized total return), interest rate risk, and default risk. The intents of these transactions are categorized as follows:
- Pay Me Now – Enhancing current yield
- Pay Me Later – Enhancing yield to worst
- Cover My Assets I. – Managing interest rate risk
- Cover My Assets II. – Managing default risk
We evaluate the transactions by determining whether they meet one, two, three, or all four enhancements. A baseball analogy for this: SINGLES, DOUBLES, TRIPLES, and HOME RUNS.
No swap trades during the month of August.
*“30-Year Treasury Yield Falls Below 2% For the First Time, CNBC, Aug. 14, 2016
**“Inverted Yield Curve and Why It Predicts a Recession,” The Balance, Aug. 27, 2019
Note: The above trades were recent block trades and do not reflect all trades done on an individual specific basis. Sound Income Strategies, LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Past performance is not an indication of future results. Be sure to first consult with a qualified financial advisor or tax professional about your specific financial situation before implementing any strategy discussed herein.
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