July 2018 Newsletter

It’s time to talk about the yield curve.  As you may know, I have had a note taped to my computer for eight years now.  The note reads:

Relative valuations (stocks) remain favorable (to bonds) until 10-year bond yields rise to 3.5%.          

Since the 10-year U.S. Treasury bond now sports a yield of just 2.88%, as of this writing, we are hurtling toward a time (perhaps 2019) when investors see the allure of bonds as equal to that of stocks.  But, that time has not yet come.

No, not yet.  However, when the 10-year treasury does perk up to a 3.5% yield, the attractiveness of bonds over stocks also depends upon whether the yield curve is inverted or not.  An inverted yield curve is an interest-rate environment in which long-term debt instruments have a lower yield than short-term bonds of the same credit quality.  This type of yield curve is the rarest of the three main types of yield curves and is considered a precursor to an economic recession.

So, Investment orthodoxy holds that the economy careens into recession and stocks viciously contract following an inverted yield curve.  By the way, the reason an inverted yield curve often leads to a recession is because banks cannot make money lending.  So, they don’t, and, in time, a tight monetary policy often leads to recession.

While an inversion has preceded each recession over the past 50 years, the lead time is extremely inconsistent, with a recession following anywhere from 14-34 months after the yield curve inverts (goes upside down).  Importantly, equities rose 15-16% on average in the 18 months following inversions, with a range of -11% to +30%.

Historically, an inverted yield curve has been accompanied by a variety of other ominous economic signals including massive layoffs, corporate or consumer credit deterioration and corporate declining free cash flow.  However, the U.S. economy appears in good shape just now as the following charts illustrate. In addition, the yield curve can remain flat for years. Also, the yield curve can invert for a small period such that consumer credit, housing starts, global PMI and GDP do not require further stimulus.

While cash balances have been raised in order to benefit from enhanced volatility, this strategy is expected to lower returns relative to the major indices until a major downside event washes valuations to the lower end of the equity trading range.  However, over a five-year time frame, this strategy should lead to a less volatile reward trajectory.


Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal.  Past performance is not a guarantee of future results.  Asset allocation cannot assure a profit nor protect against loss.  Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed.  Views expressed in this newsletter may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/ VWA0229


Sources: U.S. Equity Strategy, Yield Curve Inversion Won’t Signal Doom, July 23, 2018, Research Credit Suisse Analysts: Johnathan Golub, CFA, Patrick Palfrey, Manish Bangard, Erica Cid