The US yield curve recently “inverted” – the 3-month US Treasury yield pushed past the 10-year Treasury yield by 7.5 basis points on March 27 – leading many investors to wonder what’s next for the US economy. An inverted yield curve historically has been a fairly reliable leading indicator of a US recession.
While all US recessions since 1970 have been predicated by a yield-curve inversion, we, however, don’t expect a recession in the next 12 months. Plus, years of ultra-low rates could make this inversion less significant than others.
Investors can still find opportunities to earn income and potential return.
A majority of economists expect US growth to slow this year. US real GDP growth has already been falling, moving from 2.9 percent in 2018 to 2.4 percent in 2019, according to Bloomberg consensus forecasts. However, there are few calls for a US recession over the next 12 months.
The Federal Reserve – which is one of the more notable forecasting institutions – seems to have the most conservative estimate for 2019 growth, at 2.1 percent. This still remains above potential output (the estimated maximum sustainable output). According to Bloomberg, most estimates show US economic growth moving downwards next year, towards potential growth of 1.9 percent in 2020. It is at this level where vulnerabilities may start to rise, particularly if the economy experiences a shock – whether from within US borders or from abroad.
Notably, the inverted yield curve could have an impact on US consumer confidence – and on investment management firms, particularly those driven by algorithmic models. As trade recession warning signals emerge, uncertainty and bouts of panic could increase in the economy and markets, which could ultimately create a self-fulfilling prophecy that sends the economy into a downturn. So far, however, the reaction in risk assets and the broader economy has been relatively tempered.
In addition, given that yields in the US have been held to ultra-low levels for nearly nine years, a yield-curve inversion may not be as meaningful this time around. Former Federal Reserve Chair Janet Yellen said as much at a recent investor conference, noting that “in contrast to times past, there’s a tendency now for the yield curve to be very flat.” She added that this tendency makes it easier for the curve to invert.
In her recent comments, Yellen also seemed to send a calming message, stating that “yes, growth is slowing, but I don’t see it slowing to a level that will cause a recession. In fact, it might signal that the Fed would at some point need to cut rates.”
Here are three themes for investors to keep in mind:1. The “hunt for income” is becoming critical. Lower long-term yields and generally low inflation globally mean that the biggest risk may be to avoid taking risk. Investors should consider maintaining exposure to risk assets as they aim to meet income and return targets, and as they seek to guard against wealth erosion over time. To enhance portfolios, look for strategies that offer the potential for outsize income, both domestically and abroad. In the US, particularly for higher-yielding strategies, we continue to favor shorter-duration assets, and we believe active management is becoming increasingly critical at this point in the economic cycle.
2. Equities can continue to perform well. In a flattening or inverted yield-curve environment, “growth”-style equities may be valued at a premium as growth becomes harder to find. Look for winners from disruption in areas that have long-term secular stories – including cloud computing, mobile payments and cyber-security.
3. Global diversification is critical. Consider taking a “barbell” approach to investing in global markets. On one end, the US could be a source of stability in developed markets; on the other end, China and select emerging markets can provide growth potential. If China’s economic stimulus continues making an impact, if the US and China continue moving towards a trade deal and if the US dollar stabilizes, this approach could be particularly attractive. In addition, European dividend yields may become increasingly appealing over time, with the Euro Stoxx 50 index yielding 3.6 percent and the FTSE 100 index nearly 5.0 percent.
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