After seeing the huge market movement the other day when the 2 year Treasury yield briefly surpassed the 10 year, it makes me wonder if the largest stock holders and traders are using simple technical rules now. If humans had been driving the sell decisions, I don’t see how they could have done it in such a synchronized fashion across so many firms.
Comments are welcome.
That’s why there should be a small transaction tax. That would kill the computer driven rapid trading and give humans an edge.
I also think maybe what were once arcane market timing rules and indicators are now “conventional wisdom” repetitively iterated into people’s brains thanks to the internet and social media and 24/7 financial media to the point where it becomes market mass psychology.
First, how is selling now rational? Assuming inversion of the yield curve is an accurate signal this time wouldn’t it signal a recession about a year from now? And historically, the market downturn is not immediate either is it? I defer to Georg and others if my impression is not correct on this.
But assuming I am correct that acting now is premature then we must have some irrational retail investors.
And I would hypothesize some professional traders are playing the market to get some money from those retail investors. Furthermore, I think the professional activity would magnify this.
For example, smart traders and AI would sell short before the retail investor sells. This short selling would, I think, magnify the downward trend and may even initiate it. And those more intelligent traders and machines would have more than just the inversion of the yield curve itself. They could find confirmation in trade volumes, news readers, maybe monitoring Google searches, social media etc.
Anyway, I suspect that when the sentiment of this forum turns positive the timers will have already given some up to the pros and AI.
To be clear, that does not give me any insight and your best bet would be to do the opposite of this retail investor’s advice (should I give any).
-Jim
The stock market is a “discounting mechanism.” In english, that means it does not reflect the present or the past. It moves based on expectations of the future. If you think a recession is coming in 6-12 months, you need to be selling now. The time to get back in is when the recession is here.
So if the inverted yield curve is, truly, a precursor of recession, then now really is the time to sell.
The challenge is whether the yield curve inversion really means what it has usually meant in the past. As I’ve said here in about a gazillion different contexts, models can never be naively relied upon given the way the environment from which the data is drawn changes.
The logic of yield-curve inversion > recession goes like this:
- Strong business is accompanied by rising inflation which exerts upward pressure on interest rate.
- Since high inflation is anticipated, logic dictates that one who lends for a term of 20-years will need a higher return than one who lends for 1 year — to compensate or the way inflation is expected to erode the principal to be repaid in the future.
- Weakening business conditions are associated with diminishing inflation, or possibly deflation (which, if it happens, would actually be quite horrible).
- That means one who lends for 20 years will see less erosion in the value of principal (and in extreme cases, appreciation when one factor in deflation).
- So when recession is expected, it’s natural for lenders to get lower rates for 20 year loans.
That’s a rough schematic of how it works (there are details I glossed over).
The model depends on normal economic truisms actually holding up. That means expansion has to be associated with rising rates and rising inflation. That is not what has been happening. We’ve had a prolonged expansion accompanied by interest rates that continued to decline and by inflation that’s persisted at snooze levels.
Therefore, the world that gives rise to yield-curve inversion >> recession truism no longer exists. Domestic interest rates today are being driven, not by business conditions but by politics, global risk-allocation choices, and deference to market psychology (fear of what interest rate increases would do to a market populated by decision makers too young to have ever experienced a textbook business cycle in which stock response to earnings can offset p/e contraction due to high rates.
I have no idea when recession will. The way to look for recession is to look for dysfunctional extremes. Interest rates are not likely to figure in at all. Our fortunes, one way or the other, will more likely be driven by political developments, both domestic and international. This is why tweets by you-know-who tend to be more influential than the yield curve in terms of market action (once the media hysteria, driven by re-writing yield curve stories that date back to the ‘70s and beyond, fades out of the news cycle). As we move forward, election news should take on increasing prominence.
Exiting the stock market earlier than 5 months before a recession is likely to be counter-productive. The average lead time to recession after the 2-yr and 10-yr yields invert is 15 months. (The shortest was 9 months since 1967.)
So we should be ok for the next 10 months to June 2020.