December 27, 2005

Inverted Yield Curve - NEVER a healthy sign for ECONOMY

Looking for more signs of an economy that looks good on the surface - mall parking lots's, restaurants, home prices, but troubled underneath, check out today's yield curve.


I was reading about it this morning and was looking for a simple explanation. Sure enough, trust the blog world. Here is Bill Cara's interpretation:


December 27, 2005
Inverted yield curve, Tues., Dec. 27, 2005, 7:37 AM
Traders who want to see the "living yield curve" can go to this link, and slide the diamond symbol at the bottom of the chart along the date line. At different points over many years where the yields invert, you might wish to look at the broad market indexes at that same time.

Early this morning, the yield on the 2-year U.S. Treasury Note was higher than the 10-year. A pure definition of an inverted curve says that the 10-year yield is less than the T-Bill yield, but today where the 2-year is higher than the longer-term yield, that is a serious problem for bank and mortgage lenders.

Moreover, an inverted yield curve condition in financial markets has a perfect record in indicating an unhealthy economy.

Rather than get caught up in discussion of recession vs no recession, equity traders need only concern themselves with what I refer to as an “unhealthy economy”.

Gains that are being made in the economy today are largely resulting from (i) increased use of debt, and (ii) the wealth effect from equity and house prices, which, due to the speculative premium that exists at times, is not sustainable.

A healthy economy needs investment that produces real wealth in the form of new goods and services, priced in constant money value i.e., inflation-adjusted.

The inverting yield curve is telling us that too much capital today is being directed to trading for financial gain as opposed to investment to build real wealth. These situations never end well for traders who chase prices higher who are unskilled at the game of musical chairs.

Going back to the Living Yield Curve, you can see that in 1979-82, at the last peak of the gold cycle, and going into recession, there was an inverted yield curve. You will also see one in 1989-90, going into recession, and one in 1Q2000, at the peak of the last equity speculative peak. The only time that I can see in recent years where the yield curve was normal during a stock market crash was October 1987, and that had a lot to do with the rapid run-up in debt and the increased margin rates at the time.

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