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Portfolio > Asset Managers

Is the Yield Curve Different This Time?

By Mike Patton

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One of the greatest benefits of operating as an RIA is the “Fee-Only” aspect of the business.  Although commissions can provide a boost to revenue, it’s the recurring fees that sustain you during extreme times. And these are extreme times. 

Because of the recent market turmoil I decided to take another look at each client account and measure their returns from June 30th (our last review) through the end of the day Thursday, September 22nd. The range of account returns over this period was +0.64% to -6.82%. The return of the Dow for the same period was -13.54%.

Although I am not terribly upset with the results, I would like to have generated positive returns. I suspect no matter how bad things get, I will always feel this way. The problem is that during periods of extreme risk, only a few asset classes perform well and no matter how diversified you are, diversification alone will not save you.

This time, as it was during 2008, it was long-term government bonds that performed best (excluding 3x inverted stock bear funds). However, with the 10-year Treasury yielding just 1.80% at the time of this writing, I fear that a move to this asset class now might be a bit late. The key is to get in front of the trade. Besides…how far can the long-term yield fall? Which brings me to my next subject: the yield curve. 

Typically, an inverted yield curve is a precursor to a recession. In fact, I found a chart with varying recession probabilities based on the degree of inversion. However, I think we can throw out most of the “historical” evidence as this time it really is different! Can anyone remember when the yield curve was so compressed at such low levels?

Let’s assume fear returns to the global markets, a thought that’s not too hard to imagine. The catalyst could be Europe or maybe even Japan as it is the most indebted nation on the planet. Plus the Japanese have to deal with some very difficult post-disaster issues.

In such an event, money would flow to U.S. Treasuries and the yield would fall further. How low could it go? I suppose it depends on how fearful investors become. Also, at what point would the yield become so low that investors would look elsewhere? In this case, another asset class would emerge, or at least share, the title of “Most Safe Investment.” Care to venture what this might be? 

Thanks for reading!

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