Investments

Interest Rates and the Yield Curve

By Dean Barber

May 3, 2019

Hi, I’m Dean Barber,  Founder, and CEO of Barber Financial Group. It’s May 1st. Welcome to the economic update. Today we’re reviewing a little bit about what the markets have done so far this year, where they’re at today, and what’s changed since the 4th quarter of 2018. We’re going to discuss interest rates and the yield curve to give you an idea of where we are today. We’ll talk about what we’re thinking about the markets and what we’re thinking about the economy. As well as what some of the indicators out there are telling us today.

Interest Rates and the Yield Curve

Let’s start with taking a look at interest rates and the yield curve from a historical perspective. I spent some time on this last month, and I want to spend more time today. But today, I want the focus to be more around market reactions towards the end of economic cycles. Market reactions towards the end of economic cycles can be extremely violent. They can look like they have nothing to do with the underlying fundamentals of the economy. So, when we asked the question, “What’s changed since the fourth quarter of last year?” There’s only one thing and that is Jerome Powell, our Fed Chairman’s, stance on interest rates and the yield curve.

Entering the 4th quarter of last year, he kept saying, “We’re going to raise rates four times this year and then raise rates 2 or 3 times next year.” He acquiesced late December. Now the odds of a rate hike in 2019 have seemed to have faded. We don’t know exactly what that’s going to look like. However, we do know that’s the only thing that’s changed. The reality is, if you fell asleep on October 1st and woke up on May 1st, you’d think it was pretty boring. To clarify, the markets are almost exactly where they were on October 1st.

The thing is though, is that corporate growth and global growth have slowed drastically. Corporate profits are slowing drastically. However, we seem to have ignored that fact. Maybe thinking somehow the Fed is once again going to ride in on a white horse and make everything okay. But, every economy has cycles. We have expansions, and we have contractions. Last month I brought this up, contractions are nothing to fear, but they have to be understood.

The Yield Curve

As I go through the data today, I don’t want you to panic. I want you to understand when we do the financial planning for you, we take into consideration the possibility of poor market conditions and economic recessions that could occur at any point in your lifetime. As a result, we stress-test those things in your plan. It’s important that you sit down with your financial planner here at Barber Financial Group to understand your portfolio’s position. Then, run that portfolio back through the 2001.com Bubble. Then run that portfolio through the 2008 financial crisis. If you don’t like what it looks like and if it causes your plan too much stress you need to have a conversation about your options and how this fits into your overall plan.

March 2000

Interest Rates and the Yield Curve - Yield Curve March 2000Figure 1 – StockChart.coms – https://stockcharts.com/freecharts/yieldcurve.php

Let’s focus on the end of market cycles. I want to focus on the volatility that occurs at the end of market cycles. Looking at Figure 1, I shared this chart with you last month–and this is the yield curve dictated by interest rates. On the left side, you have interest rates and you can see the yield curve on the 2-year, the 5-year, the 7-year, and a 10-year treasury. You’ll notice the inversion. You’re getting higher yields on the shorter end of the curve. We’re looking at March of 2000 in Figure 1, and we have a steep drop in the markets.

Interest Rates and the Yield Curve - Yield Curve July 2000Figure 2 – StockChart.coms – https://stockcharts.com/freecharts/yieldcurve.php

Now in Figure 2 , it’s difficult to see on this chart but you have a steep drop in the market and then an immediate rebound where the market rebounds about to where it was before. So people could have been saying at that point in time, “Ok, we had that little drop and then we had that little correction. In fact, we had a couple of those back here in 2000.”

March 2007

The truth is there were two rallies in 2001. Two rallies that both exceeded 20% within about four months. So what we’re seeing in the first four months of this year isn’t abnormal at the end of a cycle. It doesn’t mean that everything’s okay, we’re out of the woods and, just because Jerome Powell says that he’s not going to raise rates anymore this year that that means it’s all good and it’s off to the races. You’ve got to look further at the fundamentals that are underlying the economy and corporate America today. We all know what happened after July of 2000 where you started into the dropdown and the dropdown ultimately ending in the early part of 2003.

Interest Rates and the Yield Curve - Yield Curve March 2007Figure 3 – StockChart.coms – https://stockcharts.com/freecharts/yieldcurve.php

Then in 2007 and 2008 with our yield curve inversion in March of 2007, Figure 3. Even though that yield curve inverted with interest rates higher on the short-end than the long-end, which is pointing towards the high probability of a recession in the future, the markets continued up. We see a little bit of a correction and then another leg up, and people are thinking, “Ok, well it exceeded the high that it was before, but everything’s okay now,” and then all the sudden that next dropdown, it didn’t come back up. As you can see in Figure 4 below.

Interest Rates and the Yield Curve - Yield Curve February 2009Figure 4 – StockChart.coms – https://stockcharts.com/freecharts/yieldcurve.php

Yes, there were some violent swings back up there, but my point is this. At the end of an economic cycle, we’re going to have the volatility. You see it here in Figure 2, and you see it Figure 4.

March 2015

Interest Rates and the Yield Curve - Yield Curve March 2015Figure 5 – StockChart.coms – https://stockcharts.com/freecharts/yieldcurve.php

As we fast forward, we can see in Figure 5, this volatility we had back here in 2015 and 2016. We also take a look at the yield curve over on the left of Figure 5. We know that we didn’t have that inverted yield curve. So, we know that what was really going on here was the end of quantitative easing.

Interest Rates and the Yield Curve Today

Interest Rates and the Yield Curve - Yield Curve March 2019Figure 6 – StockChart.coms – https://stockcharts.com/freecharts/yieldcurve.php

As we fast forward into 2018 in Figure 6, we notice that the inverted yield curve that I showed you last month, it is still there. We’re inverted here from the 2 to the 10-year and the 3-month to the 10-year, and it doesn’t mean that a recession is going to happen in the next month or two, but it does mean that a recession is highly likely within the next 12-18 months. Many of the large institutional money managers that I have an opportunity to speak with regularly are saying the same things–that we see a slowdown in global growth and we see a slowdown in the money supply.

We’re seeing a lot of different things happening today that are causing us to say we should be a little bit more cautious at this point than aggressive. With that being said, it’s easy to look at what the markets have done this year and say, “Gosh I wish I would have had 100% of my money in the markets so far this year.” But as this thing rolls over and as it turns around, we have to maintain the discipline.

Whether you’re in one of our tactical investment strategies or one of our passive asset allocation strategies or actively managed strategies–all of those strategies are going to perform differently at different points in time. And it’s important that you speak with your advisor to understand. All of the strategies will work, they’re just all going to look a little bit different, and they’re going to do it in a different way, so understanding how you can stress test each one of our investment strategies through your financial plan is critical.

April 2019 Market Performance

Interest Rates and the Yield Curve - April 2019 Market PerformanceFigure 7 – Chaikin Analytics – https://www.chaikinanalytics.com/

Let’s take a quick peek at what’s going on with the markets so far this month. (Figure 7) If we look at the markets in April, you can see the best performing sector is the NASDAQ. The technology-heavy NASDAQ gained 3.73% in April. The S&P 500 came in at about 2.8%, and the Dow Jones Industrial Average was the lagger at 1.57% but, across-the-board we did continue to see strength. We’ve had some surprises come out in corporate earnings where some corporate earnings have beat estimates. We have to remember that a lot of the estimates out there  – were estimates that were already revised lower.  So, just because we have some profits beating estimates, it doesn’t mean we still see growth in corporate profit. We actually see a reduction.

Now, as things rolled out in the first quarter – it’s possible that the corporate earnings recession that I started talking about in the last quarter of last year may not be here in the first quarter of this year or the second quarter this year. Maybe it will be in the 2nd and 3rd quarter. But there’s no doubt anything has changed fundamentally in economic conditions since the fourth quarter of last year.

In Conclusion

The only thing that’s changed is the fact that Jerome Powell has paused raising interest rates, which affects the yield curve. Economies go through cycles, and a contraction follows every expansion. Nobody puts it on a calendar. A defensive style of management can sometimes be early, and it can sometimes get a little bit wrong. But once that real bear market hits, you need to understand how your portfolio might react in that bear market. Most importantly, you need to understand how it affects your overall financial plan. Because at the end of the day, everything comes back to your financial plan and you being able to live your one best financial life.

Thanks for spending a few minutes with me. I’m Dean Barber, Founder, and CEO of Barber Financial Group. If you’re looking for a second-opinion or looking to stress-test your portfolio for the future, fill out the form below or give us a call anytime at 913-393-1000. 

Dean Barber
Founder & CEO

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The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.