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Should You Be Concerned about the Inverted Yield Curve?

As the bull market has ranged higher and higher, the bears have repeatedly predicted its demise. And they have been wrong again and again. Nevertheless, all bull markets do finally end or at least experience a substantial correction. What are the signs you should look for as tip offs that the economy and stocks are about the experience a setback? In an article about slowing cash flow in the corporate world Bloomberg notes that investors should be concerned about the inverted yield curve.

Concerns over a flattening U.S. Treasury yield curve – a sign to some of a coming economic slowdown – have quieted down for the moment, thanks to the recent pick-up in longer-dated yields. But the potential slowdown message has an echo in diminishing corporate cash flows, SocGen strategists including Andrew Lapthorne have highlighted.
There’s been a “steady” decline in the growth of net operating cash flow in U.S. stocks, excluding the financial and energy sectors.

The slowdown for the broader group of companies is noteworthy because it’s coincided with both a slump in the dollar and a decline in the yield curve, said the strategists. An inverted yield curve, which will occur if the trend continues, has historically come before economic slumps like the one that started about 10 years ago. And a falling dollar could reflect relatively more positive investor sentiment about economies outside the U.S.

How about the inverted yield curve? What is it and should you be concerned? Investopedia writes about the inverted yield curve.

An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession.

Typically investors demand a higher interest rate if they are going to tie up their capital in a long term bond or CD. When investors start losing faith in the stock market and want to hold cash instruments they will flock to long term bonds and CDs and drive those rates down. Thus an inverted yield curve is indicative of a lot of investors starting the hedge their bets in expectation of economic and stock market downturns.

Broad Based Indicators

Congress just passed legislation to increase the debt ceiling and remove the government from a shutdown. And the market rallied. Many investors are still excited about the Trump and Republican tax cuts. But there is an underlying concern. And that concern is seen in the inverted yield curve. Many investors are slowly but surely moving their money out of stocks and short-term bonds into long term bonds. They are doing this for a variety of reasons, all based on their belief that the economy and the stock market will falter. The value of the inverted yield curve as an indicator is that it is broad based thus indicative of a lot of people who have arrived at the same conclusion by a variety of routes. This is why you should be concerned about the inverted yield curve.





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