Treasury Yield Curves, Recessions, and the U.S. Stock Market

Treasury Yield Curves, Recessions, and the U.S. Stock Market

By: Kevin Slater

One of the best predictors of a forthcoming recession is the pattern of yields of U.S. Treasury securities (aka the Yield Curve). When 2-year Treasuries are paying higher interest rates than 10-year Treasuries, a recession is likely coming within the next year or two.

At present, we see a very “flat” yield curve which is to say there is not much difference in the interest paid from shorter-term Treasury Bills and longer-term Treasury Bonds.

Source: Federal Reserve

We expect to see a recession at some point as it is a part of the normal economic or business cycle. We are in a period of steadily rising interest rates, modestly higher inflation, low and falling unemployment, and continued economic growth. All of these factors are drags on economic growth and business profits.

In light of this information, how should we adjust the portfolio? History is mixed; while economic cycles influence investor expectations, they are distinctly different from market cycles.

During half of the recessions since 1947, the U.S. stock market continued to rise! In fact, history suggests more often than not, the worst of the stock market performance is in the year prior to a recession actually occurring.

Source: National Bureau of Economic Research

We continue to believe that it is extremely difficult to time the markets and therefore we do not expect to make any major changes at this time. Our plan is to stay diversified and to continue looking for long-term opportunities that might arise. Those changes have and will most likely appear as minor adjustments in asset allocation and very occasionally as changes in managers.

For example, we have already shortened duration and reduced credit risk in the bond portfolio in anticipation of an eventual recession. We kept our overall fixed-income allocation about the same but changed a couple funds within the portfolio. We expect to increase duration after the Fed discontinues raising interest rates. As events tied to trade agreements and the European Union play out, we may make minor adjustments to our allocation to non-U.S. equity holdings relative to U.S. equities.

Thank you for your continued trust as we work to balance long-term expectations with short-term concerns.