It was another wild week on Wall Street, or in today’s world, a wild week looking at the financial markets on a computer screen.  Stocks went on a roller coaster ride, although it was more down than up.

This was largely in tandem with falling interest rates.  Rates across the board fell, but long-term rates fell more dramatically.  The 10-year yield got down to 1.5% at one point, while the 30-year yield on U.S. Treasuries briefly dropped below the 2% barrier for the first time ever.

The 20-year yield is now lower than the short-term rates.  The 30-year yield is close to the short-term rates and is currently below the one-month yield.  The 10-year yield has already been below the short-term rates.

In other words, the yield curve is mostly inverted, which is a classic and reliable indicator for recession.  For some reason, CNBC and much of the rest of the financial media were talking this week about the 10-year yield briefly inverting with the 2-year yield.  But this is almost meaningless at this point.  The 20-year yield and 30-year yield are already below the 1-month yield.  It would be like someone pointing out that there is a hurricane 500 miles offshore, while there is a tornado headed straight for you that is a mile down the road.

The mainstream media, surprisingly, is actually mentioning the word “recession”.  There are some people who are saying that, this time, things might be different.  You always get that.  But there are regular establishment talking heads who are warning about the possibility of recession.  And I don’t think it is just because Donald Trump is president.

Speaking of Trump, he is setting up Powell and the Fed to take the blame when things go bad.  But Trump keeps carrying on with his tariffs and threats of tariffs, so I think he is going to take a good part of the blame when the economy sinks, assuming he is still in office.  As harmful as the tariffs are, I don’t think they will be primarily responsible for a recession, but the general public may think differently.

Trump even mentioned the inverted yield curve in a Tweet.  Someone made him aware of this.  And the media is catching on as well.  I don’t remember a lot of talk about the inverted yield curve back in 2006 and 2007, but maybe I am just forgetting.

Don’t get me wrong here.  The news coverage on CNBC is not all about the yield curve and the likelihood of an upcoming recession.  They can only talk about this so much.  They will carry on talking about a CEO who resigned or a corporate board that is shaking things up.  They will talk about new business ventures and mergers.  But as much as they talk about this stuff, it becomes mostly meaningless to the average investor if a recession hits.  Even if you pick a seemingly good company to buy, your shares will still likely go down in a recession.

Cause and Effect

The interesting phenomenon to me is that stocks don’t go down in tandem with the long-term yields. While nothing is guaranteed in life, an inverted yield curve is a nearly fail-safe indicator that a recession will begin within 24 months.  So why don’t stocks price this in?

If the Federal Reserve comes out and says that it will probably lower its target rate at the next meeting, stocks will likely go up.  They may not go up on the actual day when the target rate is lowered.  That is because the price already reflects the news that was known.  This is why you may here the saying to buy on the rumor and sell on the news.

It’s also the same reason that a company with zero profits may be worth millions or billions of dollars.  The market anticipates that there will be significant profits some day in the future.

So that brings us back to the yield curve and stocks.  Why don’t stock investors sell as soon as the yield curve inverts?

I don’t know if I have a good explanation for this other than to say that the bond market is more sophisticated than the stock market.

Think about all of the average people you know who contribute money to a retirement plan and the money just automatically goes into an index fund.  Most of these people are not sophisticated investors. They probably know nothing about the yield curve, and if they did, they wouldn’t act on it.  It actually takes effort to go into your 401k account and sell off some of your mutual funds to put them in bonds or a money market account.  Some of them may do this when they see that the market has crashed 30% and they start to panic, but they won’t do it when stocks are near their all-time highs.

Now let’s think about the sophisticated stock investors.  They know that, historically, there is a time lag between when the yield curve inverts and when stocks have a major sell-off.  You almost have to wonder if some investors are just waiting to get out.  They are going to take advantage of one last bull run.

I am not willing to take that chance.  I would rather be out too early than too late.  I own some stocks as part of a permanent portfolio, and I also have some gold funds for speculation.

I would like to invest in a few bear funds (short the market) to take advantage of the situation when stocks do finally come tumbling down.  But I haven’t taken that step yet in this current cycle. The reason is because I know there is typically a lag.  The yield curve will probably flip back to normal before we actually see the recession.

So maybe I am answering my own question with my own actions.  I may decide to short the market, but I haven’t done it yet. I won’t wait 24 months though. Maybe I will start shorting a little bit in a few months and then add to my position in early 2020.  I do expect the recession to begin in 2020, but I obviously can’t guarantee this.

My own actions are giving me the only logical explanation on why stocks have not already completely crashed given the inverted yield curve.  The people who actually pay attention to the yield curve understand that it takes time for things to play out.

The yield curve does not cause a recession.  It is a recession indicator.  Investors are locking in longer-term rates in anticipation that short-term rates are going to fall more in the future.  Otherwise, it wouldn’t make sense to take a lower rate on a longer-term debt instrument when you can buy a short-term Treasury with a higher rate.

Maybe the recession will happen faster than it has in the past.  Maybe stocks will crash faster than in the past as compared to when the yield curve inverted.  I am not ready to speculate on this yet, but I am also not willing to bet that it won’t happen.  Still, my best guess at this point is a recession and stock market crash in 2020.