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U.S. stocks are holding steady despite what many see as a reliable recession indicator, and Wall Street experts are similarly unfazed — at least for now.
On Friday, the spread between 3-month and 10-year Treasury notes dipped below 10 basis points for the first time since 2007, indicating an inverted yield curve — when short-term yields rise above longer-term yields.
To many, an inverted yield curve signals an oncoming recession. But analysts and economists are largely split — and mostly underwhelmed — by the latest test of the market’s resilience.
Bespoke Investment Group co-founder Paul Hickey, for one, said the significance of the inversion will depend on how long it lasts:
“The importance of the yield curve is how long are we going to be inverted for? […] The longer you have this situation, the higher the risk goes. I think if we can go a few days inverted and then start to steepen again, I don’t think the concerns are as worrisome. … Our big area of focus is the semiconductors, and they’ve been a great leadership [group] for the market overall over the last six years. Every major sell-off in the stock market has been preceded by underperformance.”
James Camp, Eagle Asset Management’s managing director of strategic income, was more bearish:
“The issue for the equity market is the bond market telling you that global growth has really rolled over in a material sense, and we think that’s likely. We also think that the problems in Europe … [are] indicative of what’s happening in the bunds market. We now have negative yields back in Germany, so their 10-year now is back to that negative territory that had us all spooked just a couple of years ago. So I think the yield curve is signaling slowdown, no inflation, and that risk asset prices are vulnerable. […] I think the bond market’s basically telling you, ‘Look, the next move is lower, not higher, on short-term rates.'”
Mohamed El-Erian, chief economic advisor at Allianz, was not convinced that a recession is in store:
“When something happens for the first time since 2007, people pay attention, and that’s what happened on Friday when you got the inversion. However, when you look at the economy … and also when you look at the determinants of the yield curve shape and move, this is not signaling recession. This is signaling some very peculiar technicals in the market that have to do with what’s happening in Europe, that have to do with what’s happening in the Fed, rather than what’s happening in the economy. This economy, unless it gets disrupted by a major policy mistake, is on its way to 2.5 to 3 percent growth for this year. […] This is a strong labor market. We continue to have average monthly job creation well above what you would expect at this time of the cycle. You’re having real wage growth, and people are coming back into the labor market. Business investment is picking up; that’s good news for this year and next year. And, yes, the effects of the tax cuts are eroding, but against that, government spending is increasing. So, put it all together: this still has momentum. This economy still has momentum for this year. There’s no way you’re going to get a recession.”
Bank of America-Merrill Lynch Global Research’s head of U.S. equity and quantitative strategy, Savita Subramanian, noted that the market typically sees 12 months of gains following an inversion, and that creates opportunity:
“The Fed’s tone has shifted so aggressively to a dovish stance that I think the real opportunity today is in consumer discretionary stocks. In fact, we just upgraded the sector from underweight to overweight, … and what’s interesting is that consumer discretionary has been left for dead. And what I mean is the average mutual fund has a lower weight exposure in consumer discretionary stocks than they have since the financial crisis. […] Normally, this late in the cycle, the U.S. consumer would look very different, but this time around, consumers haven’t taken on as much leverage. Again, if you look at all of the balance sheet measures for consumers, they look really unusually healthy at this point relative to where they ought to be given how much the government has tried to encourage us to take on more and more debt.”
Tom Lee, head of research at Fundstrat Global Advisors, made an even bolder call:
“I know the yield curve’s inverted, but the front end is like Chicken Little. It has inverted as early as four years before a recession. The real curve to watch is the 10-Year/30-Year, and that’s been steepening. So it might be too early for people to get neutral. And then we did a report last week to show that there’s a lot of indicators that show we’re mid-cycle in the U.S. […] I think it’s contrarian to say we’re mid-cycle, but if you look at [the] employment-to-population [ratio], usually, it peaks at 64 percent. That’s 10 million more jobs, or about 300,000 a year for three more years.”
