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Yield Curve Inverts, Recession Now Likely - Money Matters for 12/20/05
As has been reported here in previous columns, an inverted yield curve is nearly a 100% predictor of recession occurring in the following 12 months and Treasury bond yields have been close to inverting - having been at equilibrium, as concerns the 2 and 3-year notes, at various times over the past two months - for the past 3 to 6 months.
Today, bond yields inverted.
The 2 year yield, according to Yahoo Finance, was higher than both the 3 and 5-year yields. The 2-year stood at 4.36%. The 3 and 5-years were both yielding 4.35%. The curve has also been flattened to an extremely narrow 7 basis points between the 2-year and 10-year yield.
This is news that probably won't be covered to any great extent by the mainstream press, though the New York Times has in fact provided some very poignant remarks in a story published two days ago (December 18).
According to the article by Mark Hulbert in the NY Times, Arturo Estrella, an economist at the Federal Reserve Bank of New York, contends that an inverted yield curve "has predicted essentially every U.S. recession since 1950 with only one 'false' signal."
Coming from an economist from the Federal Reserve itself, I'd say you can take Mr. Estrella's analysis "to the bank."
Not wanting to misrepresent what I am getting from other web sites and information sources, the first instance of inverted yields actually occurred on Monday according to the folks at ForexTV, in this article.
So, what does this mean to investors?
Considering the already-dicey situation in US equities - stocks at close to 4 1/2 year highs, the absence of a Santa Claus or "holiday" rally, the probability of at least another 1/4-point interest rate hike by the Fed in January, record trade imbalance and federal deficit - my call to get out of stocks two weeks ago continues to look like sage advice.
As of this writing, I'd say recession within a year is a very good bet and a major correction in the stock markets - on the scale of 20-25% within 3-9 months, is a distinct possibility. We're talking about the Dow bottoming out around 8,000, the Nasdaq sliding below 1700 and the NYSE Composite declining to less than 5800.
A recession, which is technically two consecutive quarters of negative growth in the GDP, could not be detected by this measure until - at the very earliest - April of 2006. That would only occur if the current quarter comes in as a minus (not likely) and so does the 1st quarter of 2006. What's more likely, and usually the case, the usually suspect reporting of the government and news media will not inform the public that there's a recession until we're well into the throes of it. The US won't probably be officially in recession until October or November of 2006. Of course, those who act at that point will be light years behind the well-informed and will likely suffer enormous financial losses.
Since the usual case is that there's no "official" word of recession until it's too late, watching the stock markets with more than casual interest should be vital to one's economic future, as the stock market is normally a very solid predictor of future conditions. Earnings will be under pressure right from the start of 2006, as 4th quarter 2004 results offer some challenge this year as do comparisons to the 1st and 2nd quarters of 2005.
If companies don't measure up - equaling or beating year ago results - that's tantamount to firing a recession warning shot across the bow of great ship Wall Street. Considering that retailers are having a less-than-stellar holiday season, that would be the first segment to watch. After that, consumer goods manufacturers and service providers should be on the radar.
As if taking it's cue from the bond market, the Nasdaq new highs - new lows indicator rolled over into the negative today, joining the NYSE, which dipped below break-even last week.
And to make matters worse, MTA workers in New York city went on strike at midnight Monday, shutting down the nation's largest public transit system. Talks fell apart last week and the union and MTA have not set a date for talks to resume.
Happy Holidays.
Dow Jones: -30.98; 10,805.55 close
NYSE Advancers: 1641
Nasdaq Advancers: 1377
NYSE New Highs: 60
Nasdaq New Highs: 62
Gold: -9.10; 497.00 close
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