In Praise of a Near-Perfect Recession Indicator

In praise of a near-perfect recession indicator... The 'inverted yield curve' was right again... This is when markets go haywire... Why the reminder now?... This recession, by definition, may be ending...

Guaranteed signals sure are hard to find in this world...

But as I (Corey McLaughlin) have watched and written almost daily about the happenings in our economy and across the markets so far this year, I keep coming back to one indicator that's as close to a "sure thing" as you'll ever find...

It's a near-perfect recession indicator. And it's one that the co-founders of our company, Porter Stansberry and True Wealth editor Steve Sjuggerud, have both talked about and shared repeatedly over the years... They call it a major "get out" signal for stocks.

And earlier this year, it was right yet again.

The facts of the matter smack you over the head... and say, "Pay attention if you want to save or make money!"

The indicator I'm talking about is called the 'inverted yield curve'...

In the plainest English we can use, the "yield curve" is the difference between long- and short-term interest rates.

You can measure this curve in a variety of ways, but the most common is the difference between the 10-year U.S. Treasury notes and the two-year U.S. Treasury notes.

Most times, long-term rates are higher to compensate for the trouble of tying up your money for a longer period of time. This is healthy... and logically, it makes sense.

But when that relationship flip-flops, the yield curve is said to have "inverted." It doesn't happen often... But when it does, it warns that trouble is ahead for the U.S. economy.

We hear and see plenty of financial pundits opining about all sorts of things on a regular basis, but we haven't really heard anyone point out this fact very loudly...

An inverted yield curve has now preceded the last eight recessions, going back 60 years.

This is information worth sharing with all investors...

You can see the latest handful of instances in the following chart, with the last inversion occurring briefly in August 2019. (We noted this in the August 14, 2019 Digest.) The shaded areas of the chart indicate recessions. Take a look...

You'll find plenty of opinions about this indicator being "overrated" or something similar, but we're here to tell you that it matters... In fact, it was a jumping-off point in what Porter said might have been the most important Digest he has ever written back in June 2019.

We urge you to re-read that piece when you get a chance, for a "master class" on how the economy works and how all of its pieces are connected.

Porter explains in great detail what it means for your money... and why investors would be wise to hold gold and bitcoin in their portfolios. The advice is as great today as it was then.

But today, I'm simply here to point out something that can easily get lost in the shuffle of the daily noise about the markets... You can spend a lot of time looking for another indicator that has preceded eight of the last eight recessions, but we're showing you one right here...

This is when markets go haywire...

That's why as far back as three years ago, Porter and Steve were warning about the curve "inverting" or going "negative" again for the first time since 2007. As Steve wrote in the November 22, 2017 Digest...

Porter says it could turn negative by early next year. I think that day happens in 2019 or even 2020. Only time will tell... But whenever it does happen, don't take it lightly. Bear markets happen a lot faster than bull markets. And great bear markets tend to follow great bull markets.

That sure rings true today, as we look back on 2020 and see the end of the longest bull market ever... followed by a quick bear market... followed by what looks like the start of another central bank-powered bull market and the beginning of a new "Melt Up."

Of course, you must know some additional details...

An inverted yield curve is not an immediate sell signal. Longtime Digest readers know that history shows stocks have typically peaked several months to as long as two full years after the yield curve first inverts.

And while bull markets have typically continued for well more than a year after the yield curve inverts, there have been two notable exceptions...

In 1980, stocks peaked just two months after the yield curve inverted. And in 1973, the market actually peaked two months prior to the first inversion.

But as Steve wrote in a September 11, 2019 issue of his free DailyWealth letter, the inverted yield curve is generally a leading indicator...

Now that the yield curve has inverted, history says we should expect big gains over the next six to 18 months...

That was the case this time around... The curve briefly inverted near the end of August 2019, roughly six months before we entered the pandemic-induced recession.

Yet, at the same time, it was on the shorter end of the range... And Steve and his research team had other reasons to believe stocks could continue higher. After all, we hadn't seen full-blown "Melt Up" euphoria yet...

In other words, an inverted yield curve doesn't directly cause a recession – people making decisions do – but it does indicate that the environment is ripe for one to happen should a market shock or some other trigger happen.

For instance, as Stansberry's Credit Opportunities editor Mike DiBiase explained in a May 2019 Digest, an inverted curve matters big-time for the banking system...

Banks borrow money at shorter-term rates and lend money at longer-term rates. So when the yield curve inverts, they're forced to pay more in interest than they're able to charge for their loans. So they issue far fewer loans... and zombie companies that rely on banks to refinance their debt suddenly get cut off and go bankrupt.

And as Vic Lederman, an analyst on Steve's team, wrote in the August 22, 2019 Digest, this yield behavior says a lot about risk in the market at any given moment...

Normally, bond yields follow a simple rule...

Short-term bonds yield less than long-term bonds.

It makes sense... When you buy a U.S. government bond, you're loaning your money to Uncle Sam. Loaning the government money for two years is a lot less risky than loaning it for 10 years. As such, the rate paid on the shorter-term loan is low.

Naturally, longer-term loans command a higher rate. The risk is still low, but it is a little higher than the two-year. And it's more inconvenient to tie your money up for 10 years, too.

Of course, this is how the world works when things are going well. But what if things aren't going well? What if investors think things will be going poorly in the next year or two?

When investors are more worried about today than tomorrow, rates can invert.

Vic went on to describe that the Federal Reserve, which had been raising rates before last summer, was "overdoing" it again in its role... and pointed out the fact that it could lead to a recession.

Now, you might be asking, 'What good is this information now? Where was it before the pandemic?'...

Fair question.

First off, we have written about it here, here, and here in the Digest... and some of our editors have written about it, too. Plus, former Digest editor Justin Brill wrote about it before that here, here, here, and here.

We also re-ran Porter's essay in August 2019, when the latest inversion happened.

But we didn't know what the spark of the next recession would be... No one – not even us – could predict that a once-in-a-generation pandemic and the ensuing government shutdowns would prove to be the igniter. That's a risk you take being involved in the markets in the first place.

It's why you didn't hear Steve or anyone else say "sell everything" over the last year... just because the yield curve inverted in August. As our Director of Research Austin Root put it in a May 2019 Digest, while warning investors on how to prepare their portfolios for whatever comes next...

You see, predicting bear markets is a really hard thing to do...

Bear markets seem so obvious after the fact. But before they occur, it's tough to know when the music will stop and stocks will start trending down. That's because you'll see a lot of early warning signals – like slowing global growth, an inverted yield curve, widening credit spreads, and high valuations for stocks, among others – often before the crash actually occurs.

If you sold your assets at the first sign of these signals, you would have pulled out of stocks many times over the past 10 years... only to see the market rip higher.

Today, the yield of the 10-year Treasury is about 0.63% higher than the two-year Treasury. That's not great, but it's also not negative. The curve hasn't been inverted since August 2019. Stocks are back near highs today... and fuel for a new "Melt Up" is in place.

But that's why I want to point out the nearly perfect accuracy of this recession indicator today... So when you hear about it next time, likely near the end of today's Fed-juiced bull market, it will ring a few bells, no matter what else is going on the world that day.

Mark it down however you save important information. We promise you'll be glad you did.

Now, as for what comes next...

This recession, by definition, may be over quickly...

As fast as we got into a recession, we may be recovering. Central banks around the world are making sure of that... and so are "we the people." (As we wrote back in May, the recovery would happen when we said it would.)

Several Fed officials are now estimating third-quarter gross domestic product ("GDP") growth greater than 30%. That's not a recession. But remember... Whether we see growth in upcoming quarters remains to be seen, of course. These data are backward-looking.

Our colleague Jessica Stone and Stansberry NewsWire editor C. Scott Garliss talked about the recovery we're seeing today in their exclusive coverage of the International Monetary Fund ("IMF") and the World Bank's annual meetings...

In short, world economic leaders are talking up the recovery that we're seeing...

Just today, Tobias Adrian, the director of monetary and capital markets at the IMF, said the "global banking system is well-positioned to withstand further adverse economic shocks," as Scott told Jessica in a Facebook Live video earlier today...

Scott also wrote in the NewsWire today that IMF Chief Economist Gita Gopinath was very optimistic about the organization's global outlook this morning, but that it could take at least another year to get back to pre-COVID-19 conditions. From Scott's post...

In particular, Gopinath highlighted the significant rebound in the U.S. She said the recovery here is happening sooner than expected. It got underway late in the second quarter, with economic activity having changed quite a bit from April and March. And she noted that third-quarter indicators have remained strong.

At the same time, she stated the support provided by the Federal Reserve is what allowed global financial markets to stabilize. She said the introduction of this stimulus has been a significant driver of the global rebound. But the group doesn't expect there to be a return to 2019 levels until the second half of 2021 to late 2022.

Be sure to follow Jessica and Scott's work on our Facebook pages and in the NewsWire throughout the rest of this week. They're working around the clock to bring you in-depth coverage from the meetings, including live analysis and exclusive interviews.

Click here to sign up for free updates from Jessica and Scott... And you can check out their videos from today right now on our Facebook page. While you're at it, make sure you "like" our Facebook page... and follow us on YouTube, Twitter, and Instagram, too.

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In today's mailbag, a question for international editor Kim Iskyan, who penned Friday's Digest. What's on your mind? As always, e-mail us at feedback@stansberryresearch.com.

"Dear Kim, What's the gig in Dublin/Ireland or, just a vacation? Pub life must be quiet but, hopefully, you can still enjoy a Guinness!" – Paid-up subscriber Patrick O.

Kim Iskyan comment: Hi there Patrick. I moved to Dublin (from Singapore) over the summer. Singapore is fantastic but the Disney-meets-1984 vibe can get kind of old – as can the interminable, four-season humidity.

I had lived in Ireland 15 years ago, and it's great to be back – though I am looking forward to the pubs (and everything else...) reopening! And yes, I'll take a Guinness over a Tiger (Singapore's national brew) any day of the week.

All the best,

Corey McLaughlin
Baltimore, Maryland
October 13, 2020