by Bryan Perry

December 6, 2022

By now, most investors have come to understand what an “inverted” yield curve looks like and means. That’s where the 2-year Treasury Note yields considerably more than the 10-year Treasury Bond.

An inverted yield curve historically indicates a very difficult time for the economy in the coming months – like 13% inflation in 1979, the dot-com blowup of 2000, the housing crisis of 2008, the Covid-19 outbreak in 2020, or the current aggressive rate hikes to force a slowdown after a run of high inflation.

As of December 1, the yield on the 2-year T-Note stood at 4.27%, while the yield on the 10-year T-Bond was 3.54%, for a difference of 0.73%, or 73 basis points. This is the widest 2-10 spread since 1980, as demonstrated in the chart below. While one camp argues that such an inversion is a precursor to a hard landing, others contend that it marks a bottom for the economy, followed by recovery.  But in 1980, the economy was just starting a long run of recessions for eight of 14 quarters from mid-1979 to end-1982.

Inverted Yield Curve Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

What history tells us is that the economy generally suffers a material slowing the year following peak yield curve inversion, meaning that 2023 will likely prove to be a challenging year for the U.S. economy – a time of higher unemployment, lower housing prices, low GDP growth, and lower earnings for the S&P 500. For the record, not all yield curve inversions precede a recession, and last week’s market rally raised hopes that the economy will not fall into a recession, but simply endure a slow-growth environment.

Here is just one example of what’s happening – the higher cost of mortgages in today’s housing market.

The monthly payment on a 3% 30-year fixed mortgage for a $400,000 home taken out last year would be $1,349, but since rates have more than doubled since then, the monthly payment on a 7% 30-year fixed mortgage for a $400,000 home is $2,129 – a $780 increase. For a homebuyer that wants to maintain that $1,349 monthly payment per their budget, they will have to settle on a home priced at $253,000 – 37% lower. That large of a price differential must be met through higher wages, lower housing prices, or both.

There’s good news, too. History also shows that in the year following a steeply inverted yield curve, the stock market begins the next leg of a secular bull market. If the past is prologue, 2023 should be a pretty good year for stocks. There are those that argue that the bottom is in, and the next bull leg has just begun.

Some of this uncertainty will be sorted out by the actions and words at the December 14 FOMC meeting.

The Highly Fluid Oil Price is Another Wild Card in 2023

In another high-profile and highly fluid market situation, more volatility in the crude oil market can be expected. On Sunday, OPEC+ agreed to stay put on their production output targets as the energy markets contend with a slowing Chinese economy, a potential European Union boycott of most Russian oil imports, and a price cap of $60 per barrel on Russian exports imposed by the EU, the G-7, and Australia.

Some countries won’t sign on to this EU plan, and the policy directive is coming at a time when China and India are content to buy Russian oil at its current $66 per barrel price while WTI crude trades at around $81 per barrel. Russia has been effective at circumventing sanctions to date, and if there were any teeth to this new set of sanctions and price caps, oil prices would likely be trading much higher.

The resurgence of Covid in China has dampened sentiment for higher demand by oil traders as part of a long-term timeline, during which demand in China will increase when that economy fully reopens. Overt pressure from the Biden administration on OPEC+ to increase supply had also weighed on oil prices heading into last Sunday’s meeting, but that obviously did not work to the liking of the Biden White House. WTI closed out the week around $80/barrel, right where the Saudis want to maintain a floor.

West Texas Intermediate Crude Oil Price Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Back in June, the Royal Bank of Canada hosted an energy conference in New York with the highlight being a keynote speech by Mohammed Barkindo, secretary general of OPEC, in which Barkindo warned, “OPEC is running out of capacity,” and “with the exception of two or three members, all are maxed out.”  Further, “The world needs to come to terms with this brutal fact” and that it is a “global challenge” (see:

I’ll take that statement at face value: OPEC+ is running out of spare capacity. That supports the bull case for a strong pricing environment for crude oil and natural gas into 2023. Amidst all the confusion, most exploration and production energy stocks have receded from their recent highs and offer, in my view, attractive entry points, especially those with variable dividends and high-yielding domestic infrastructure.

Global Oil Demand/Supply Balance Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Foregoing major capex spending in the face of an anti-fossil fuel administration, returning free cash flow to shareholders in the form of variable dividends has turned out to be, in my option, one of the greatest inflation-fighting asset classes from both a fundamental and total return basis in 2022. In the E&P space, Coterra Energy Inc. (CTRA) yields 9.2%, Devon Energy Corp. (DVN) yields 7.9%, and Pioneer Natural Resources Co. (PXD) pays out a 10.4% dividend yield.

With oil prices having declined for much of the fourth quarter, mostly due to concerns over demand by China, the next round of variable dividends may not be as juicy as in recent quarters, but listening to oil executives, their outlook remains bullish. Speaking to the most recent earnings release, Pioneer CEO Scott Sheffield told Bloomberg, “I still think [oil] will probably get back to $120, sometime mid-next year, once China opens up.” Sheffield also said that China’s growing energy infrastructure could surpass the U.S. if the country doesn’t invest more in areas such as pipelines and liquefied natural gas terminals.

To ramp up domestic energy production, Sheffield suggested that President Biden should speak with shareholders and financial leaders who fund that industry. Personally, I don’t see this kind of dialogue happening at this time, so this will keep new development of energy sources limited and prices elevated.

A couple of high yield energy infrastructure ETFs and closed-end funds that convert the K-1 MLP income into 1099 ordinary taxable income include:

  • Alerian MLP ETF (AMLP), paying 7.34%
  • InfraCap MLP ETF (AMZA) paying 7.14%
  • Kayne Anderson Energy Infrastructure Fund (KYN) paying 9.03%

To this point, the risk/reward investment proposition looks very promising for fossil fuels energy companies as long as there is limited supply due to the Administration’s focus on renewables.

Navellier & Associates owns Coterra Energy Inc. (CTRA), and Devon Energy Corp. (DVN), in managed accounts. We do not own Pioneer Natural Resources Co. (PXD). Bryan Perry does not personally own Coterra Energy Inc. (CTRA), Devon Energy Corp. (DVN), or Pioneer Natural Resources Co. (PXD).

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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