After many months of harping on this subject, it has finally happened.  On Friday, March 22, 2019, the yield curve officially inverted as measured by the 3-month yield vs. the 10-year yield.  According to the U.S. Treasury’s own data, the 10-year yield stood at 2.44 on Friday, while the 3-month closed at 2.46.

The inverted yield curve – where long-term yields drop below short-term yields – is the best recession indicator that exists.  It is almost impossible to predict the financial markets, especially in our world of central banking and a mixed economy.  But an inverted yield curve is about the surest thing there is.

The last time these two metrics inverted was in 2007, and we know what happened shortly after that.

At this point, a recession prior to the 2020 election is looking highly likely.  I give it somewhere around a 50/50 chance of hitting in 2019.  While the inverted yield curve is great at predicting a recession, there tends to be a lag. We could still be a year out, but now is the time to prepare.

The trend had been going towards this inversion for many months now.  But after the Federal Open Market Committee (FOMC) released its latest monetary policy statement on Wednesday, the 10-year yield dropped big, while the 3-month yield barely moved.

The Fed has now said that it will stop hiking its target rate for 2019, and also that it will soon stop its deflationary policy of allowing $50 billion per month to roll off of its balance sheet.

Some are pointing to the Fed meeting as a cause for the 10-year yield dropping and the yield curve inverting.  But this may be confusing cause and effect.  I’m not saying that the Fed meeting had nothing to do with the short-term reaction of the bond market.  However, I do think it is more a case where the Fed decided to stop hiking rates and to stop reducing its balance sheet because of the flattening of the yield curve.  The Fed was acting in response to the bond market.

Last year, James Bullard warned that the Fed should stop hiking rates and challenging the yield curve.  He was already recognizing the flattening curve.

It is important to remember that the Fed already started reducing its target for the federal funds rate prior to when the financial crisis became apparent in 2008.  The point is that it probably doesn’t matter what the Fed does from here.    Powell could come out with a statement tomorrow saying the Fed has decided to start QE4 (more monetary inflation) and to reduce the federal funds rate.  If anything, this would just panic the market more.  It would not stop a recession that is already on the verge of happening.

The recession is already baked into the cake.  It was the Fed’s ultra loose monetary policy from 2008 to 2014 that caused the current unsustainable boom.

What to Expect and What to Do

You should prepare for a recession coming soon.  If it doesn’t happen in 2019, then 2020 is almost certain.  Either way, you need to get mentally prepared and financially prepared.

Getting financially prepared is obviously easier said than done.  We don’t know exactly how the recession will take shape, but we can take a pretty good guess based on past experience and based on what has happened over the last 10 years.

The most important thing is to keep your main source of income in a recession.  This is the number one priority for most people. The only exception is if you have a lot of wealth and you use that wealth (or are planning to soon use that wealth) as a source of income.  Otherwise, you need to do your best to keep your job.  Or if you are an entrepreneur, you need to plan on surviving the recession.

I don’t have a lot of advice in this area except to be aware of what may be coming and to work hard to avoid the worst-case scenarios.  If you are an employee, you want to be seen as a productive employee who is highly beneficial to your company.  This doesn’t guarantee not being let go, but it certainly increases your odds. And if you work for a company that is already on shaky financial ground, you may want to look elsewhere while unemployment is still relatively low.

Aside from your main source of income, you obviously want to do your best to protect the wealth that you already have.  The biggest boom in the U.S. over the last 10 years has been in stocks. I am referring to major financial assets when I say this.  I’m not including something like Bitcoin, although I expect that bubble to burst too.

I advocate a permanent portfolio for your financial assets. This includes 25% in stocks, but the other portions of the portfolio should get you through a recession.

I may decide to short stocks at some point.  I may just buy a bear fund or some kind of ETF that bets on a down stock market. I will avoid betting on any individual stocks falling.  If I short the market, I will do so cautiously with money I can afford to lose.

The other sector that has boomed is real estate.  This is not universal.  I don’t think housing is in as much of a bubble as it was 12 years ago.  I don’t think you should sell your house right now just because you think the housing market will go down, especially if you are comfortable with your monthly expenses and you are planning to stay in your house for a while.

There are exceptions to this.  If I owned a house in San Francisco, I would cash out now.  I probably would have already cashed out a couple of years ago, and it has only gone up more since then.  There are other hot markets in the U.S. that are likely to see big declines. In Canada, I expect the housing markets in Vancouver and Toronto to take a hit.

Aside from stocks and housing, I think it is important just to get rid of any debt that you can, and to save some money for an emergency fund.  In a recession, they say cash is king.  Maybe long-term U.S. government bonds will be king, but you probably can’t go wrong with cash (or cash equivalents).  You want some liquidity.

If you can make some little cutbacks right now, it is a good time to do so.  It will make it less miserable when the recession happens.  You will have already partially adjusted.  If you are accustomed to eating out 3 times a week, you can at least cut it back to once or twice now.  If you wait for the recession and you have to go from 3 times to zero, it will be hard on you mentally.  People get accustomed to a certain lifestyle, and it can be difficult mentally to cut back, even when cutting back on luxury items.

If you are mentally prepared for a recession, you will be much further ahead than most.  You won’t be taken by surprise.  And if you do have to adjust your lifestyle, it won’t be as much of a shock to your system.

In conclusion, a recession is likely coming soon, and you should already be in the process of preparing mentally and financially.  You can’t control what happens to the economy, but you can control many aspects of your own situation.

One last important point is that price deflation may occur in the short run.  This means that you may have good buying opportunities, whether it is for investments or consumer goods that you need.  If you need a new car, maybe there will be some good deals out there soon.  If you are looking to buy a house to live in or to invest in, be patient and wait for the buyer’s market.

Cash is king not just because of the security it gives you.  It also gives you opportunity when others are in crisis mode.