September 11, 2018

The bullish camp is mounting a serious campaign for staging a pre-election rally that could really sizzle. Second-quarter real GDP growth was 4.2% on an annualized basis and the Atlanta Fed’s GDPNow model is estimating 4.4% real GDP growth for the third quarter. But even a stellar set of economic figures can’t prevent a sharp pullback for what was simply an overbought market that still rose by over 3% in August.

There is no denying the economy is on a roll. Undergirding robust factory production, strong employment news, and services data released last week, business investment continues to trend well, which is more of a long-term indicator than most other data points, and GDP has reached cruising speed at 4% and above.

So, if all is well for the economy in terms of fundamentals, what is driving the bearish conversation lately about how the Goldilocks economy is on the verge of hitting the wall? Let’s look at the leading concerns:

  • There is a widespread belief among market pros that we are in the late stages of the expansion.
  • There are deep-seeded concerns the Federal Reserve will tighten too much and kill the expansion.
  • There are legitimate fears that growth in other developed economies has stalled or declined.
  • Likewise, fears of a protracted trade war with China could negatively impact Asian economies and weaken global markets outside the U.S.
  • Deficit spending in the U.S. and abroad at all levels has created fears of a massive credit bubble.

Guiding the collective fears of those on a “recession watch” is the spread between the 10-year and 2-year Treasury notes, which currently stands at 22 basis points, just off the recent low. There is a credible reason for investors to be watchful of the “10/2 spread,” as a recession has occurred every time since 1980 when this spread has “inverted,” meaning that the rate on the 2-year is higher than the 10-year rate.

Inversion of the 10/2 spread doesn’t mean a recession is just around the corner, though. There have been five recessions since 1980 and the average time between the first inversion and the following recession has been just over 18 months, with a range that has spanned 10 to 24 months. But, as most investors are keenly aware, the stock market will begin to adjust well before the economic contraction actually occurs.

With the S&P 500, Nasdaq Composite, and Russell 2000 all hitting new record highs in recent weeks, there seems to be a sense that the narrowing spread between the 10- and the 2-year note is not going to invert even as the FOMC is widely expected to raise the target range for the fed funds rate again at its September 25-26 meeting. The latest move up in the 10-year yield from 2.82% to 2.94% during the past two weeks appears to have minimized any inversion fears, at least for now.

A Better Interest-Rate Indicator Gives the Bulls a Green Light

Given the narrowing yield curve, why did the market surge so much in late August? A recent white paper by the San Francisco Federal Reserve of San Francisco (“Information in the Yield Curve about Future Recessions,” August 27, 2018) gave the stock market reason to think calls for the death of the economic expansion emanating from the 10/2 spread are greatly exaggerated. This new white paper – which was also published in the Wall Street Journal – runs counter to the conventional line of thinking, noted above.

While the Fed’s research acknowledges the validity of the yield curve as a reliable predictor of recessions, the main takeaway from the San Francisco Fed’s August report is the notion that the spread between the 10-year note yield and the 3-month T-bill yield is the most reliable predictor of recession among the various short-term yield spreads. This conclusion has some “Wow” factor to it. Until this paper was released on August 27th, no one talked about the 10yr-3mo spread, not even Rick Santelli!

Because the spread between the 10-year yield and the 3-month yield is a wider 72 basis points, whereas the spread between the 10-year and 2-year yield is just 22 bps, institutional fund managers took this highlighted finding to heart and it could be the #1 reason why the market vaulted higher in the last week of August. It was like a free extended pass for the summer rally and buyer euphoria just took off.

For a bull market that wants to find more reasons to run, the added cushion provided by the 10-year-3-month spread could be one such reason. But will the stock market defer to this newfound line of thinking or react in historical bearish fashion if or when the 10/2 spread inverts? I think the SF Fed’s economic analysis is well-grounded, since it has been the tradition in the academic literature to focus on the 10-year vs. 3-month spread when it comes to pegging a recession, even though financial commentators emphasize the 10/2 spread. But market bears apparently don’t like the indicator the Fed uses to forecast recessions.

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

The question going forward will be whether the stock market has the ability to look past an inverted 10-2 spread and to defer to a positive 10yr-3mo spread and whether the financial community embraces this line of thinking. For a bull market that has managed to bypass worst-case scenarios time and time again, I wouldn’t be surprised if it starts looking to the 10yr-3mo spread as its preferred yield-curve marker. This could set up the S&P 500 for a pre-midterm move up to and through 3,000 like a hot knife through butter.

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*


Although information in these reports has been obtained from and is based upon sources that Navellier believes to be reliable, Navellier does not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute Navellier’s judgment as of the date the report was created and are subject to change without notice. These reports are for informational purposes only and are not intended as an offer or solicitation for the purchase or sale of a security. Any decision to purchase securities mentioned in these reports must take into account existing public information on such securities or any registered prospectus.

Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any securities recommendations made by Navellier. in the future will be profitable or equal the performance of securities made in this report.

Dividend payments are not guaranteed. The amount of a dividend payment, if any, can vary over time and issuers may reduce dividends paid on securities in the event of a recession or adverse event affecting a specific industry or issuer.

None of the stock information, data, and company information presented herein constitutes a recommendation by Navellier or a solicitation of any offer to buy or sell any securities. Any specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable.

Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. Individual stocks presented may not be suitable for you. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. Investment in fixed income securities has the potential for the investment return and principal value of an investment to fluctuate so that an investor’s holdings, when redeemed, may be worth less than their original cost.

One cannot invest directly in an index. Results presented include the reinvestment of all dividends and other earnings.

Past performance is no indication of future results.

FEDERAL TAX ADVICE DISCLAIMER: As required by U.S. Treasury Regulations, you are informed that, to the extent this presentation includes any federal tax advice, the presentation is not intended or written by Navellier to be used, and cannot be used, for the purpose of avoiding federal tax penalties. Navellier does not advise on any income tax requirements or issues. Use of any information presented by Navellier is for general information only and does not represent tax advice either express or implied. You are encouraged to seek professional tax advice for income tax questions and assistance.

IMPORTANT NEWSLETTER DISCLOSURE: The hypothetical performance results for investment newsletters that are authored or edited by Louis Navellier, including Louis Navellier’s Growth Investor, Louis Navellier’s Breakthrough Stocks, Louis Navellier’s Accelerated Profits, and Louis Navellier’s Platinum Club, are not based on any actual securities trading, portfolio, or accounts, and the newsletters’ reported hypothetical performances should be considered mere “paper” or proforma hypothetical performance results and are not actual performance of real world trades.  Navellier & Associates, Inc. does not have any relation to or affiliation with the owner of these newsletters. There are material differences between Navellier Investment Products’ portfolios and the InvestorPlace Media, LLC newsletter portfolios authored by Louis Navellier. The InvestorPlace Media, LLC newsletters contain hypothetical performance that do not include transaction costs, advisory fees, or other fees a client might incur if actual investments and trades were being made by an investor. As a result, newsletter performance should not be used to evaluate Navellier Investment services which are separate and different from the newsletters. The owner of the newsletters is InvestorPlace Media, LLC and any questions concerning the newsletters, including any newsletter advertising or hypothetical Newsletter performance claims, (which are calculated solely by Investor Place Media and not Navellier) should be referred to InvestorPlace Media, LLC at (800) 718-8289.

Please note that Navellier & Associates and the Navellier Private Client Group are managed completely independent of the newsletters owned and published by InvestorPlace Media, LLC and written and edited by Louis Navellier, and investment performance of the newsletters should in no way be considered indicative of potential future investment performance for any Navellier & Associates separately managed account portfolio. Potential investors should consult with their financial advisor before investing in any Navellier Investment Product.

Navellier claims compliance with Global Investment Performance Standards (GIPS). To receive a complete list and descriptions of Navellier’s composites and/or a presentation that adheres to the GIPS standards, please contact Navellier or click here. It should not be assumed that any securities recommendations made by Navellier & Associates, Inc. in the future will be profitable or equal the performance of securities made in this report. Request here a list of recommendations made by Navellier & Associates, Inc. for the preceding twelve months, please contact Tim Hope at (775) 785-9416.

Marketmail Archives