While one would hope for a soft landing, today’s inverted yield curve signals that a recession may be unavoidable, cautions Jim Stack, money manager and editor of InvesTech Research.
The spread between the 10-year and 2-year Treasury yields is now definitively inverted at -0.25%, an omen that has reliably signaled trouble ahead for the U.S. economy, albeit with a variable lead time.
Some will inevitably argue that, "this time is different" and today’s yield curve inversion may not carry the same message, but with our focus on managing risk this is not a bet we are willing to make.
Thus far, the labor market has proven to be the most resilient part of the economy. However, that could soon be changing. Initial claims for unemployment, which reached a record 55-year low earlier this year, have suddenly 400 shot higher due to a recent wave of layoffs. While the upward move in initial claims isn’t conclusive at this point, a significant rise from here could be an omen that recession has arrived.
Consumers, too, are sending a message that there could be trouble ahead. While we previously noted that consumers’ inflation expectations have reached an unprecedented level, their outlook for future conditions has also worsened. Meanwhile, the outlook of small business owners, which began slipping over a year ago, has now turned into a freefall.
In total, the evidence presented above strongly suggests the U.S. economy is on a collision course with recession — despite multiple reassurances from Fed officials and economists.
One of the most valuable lessons we have learned in InvesTech Research’s 40+ year history is to not underestimate the downside risk in a bear market. Remember that every bear market starts out as a correction, and big bear markets always start as small bear markets.
If this does turn out to be a more protracted bear market, it will require great patience and discipline to safely navigate until we get to the next great buying opportunity. There are still extreme imbalances in both the market and economy today that need to be resolved — likely keeping volatility elevated moving forward.
While we don’t know exactly how things will ultimately play out, we DO know that this is a high-risk market environment. Thus, it’s more important to have portfolios positioned defensively right now than to try to predict how (and when) the economy could go into recession or the market could bottom.
So color us skeptical, cautious, and concerned about this market’s outlook for the months ahead. We cannot rule out more reassuring headlines and tempting rallies. In fact, the 2000-02 bear market and 2007-09 bear market both had three alluring 10% rallies through their painful path to the ultimate bottom.
Rather than forecast, we will continue to steer a defensive course in our Model Fund Portfolio until the weight of evidence improves. Indeed, our portfolio currently has a 44% net invested allocation — our most defensive positioning in nearly 20 years.
While market prognosticators are trying their best to eagerly anticipate “peak inflation” and call a market bottom, we are keeping our disciplined focus on managing risk in our Model Fund Portfolio in what we still see as a high-risk environment.
