Notice that the curve is very positive for the front part of the curve but basically flat after that.What it means is this. The front end is controlled by the Fed and they are keeping rates very low but steadily rising them.
But the back end of the yield curve is controlled by the bond traders. This is where it gets interesting.
Notice that yields are running about 3%. Yet inflation is over 8%. Why would someone lend money at 3% for 10 years if inflation is 8%. There are two reasons.
- Current other debt instruments have credit quality that is bordering on bankruptcy
- The market thinks inflation will drop to below 3% soon.
Now we get to the Four Horsemen.
A yield curve with that flat shape from 2 years out is a very negative but accurate leading indicator of the economy. 14 of the last 18 recessions were led by the flattening of the yield curve about one year in advance.
This recession should be as vicious as the 2008 one because both corporates and governments are much deeper in debt than they were in 2008. In addition, increased government regulations mean the economy can't react quickly enough to counteract the Fed induced recession.
Take a look at what happened in the last recession.
We saw many economic catastophe's with particularly the small business sector losing a lot money and being forced into bankruptcies.
We saw violence with the BLM riots in the summer. We will see more riots around the world this time round. Look for things like the Arab Spring to re-occur.
Bad economic times breed economic resentments and thus riots.
Look for food shortages due to a shortage of seed and fertilizer due to the energy shortage.
The bottom line is that bond yields are so low because the bond market is looking for a deep recession as am I. The bond market believes that the recession will be so severe and Fed policy so restrictive that inflation will drop below 2% in 2023.
I think the bond market is wrong and inflation will still be high even by the end of 2023 because we are just at the beginning of the inflation cycle and the Fed is not being aggressive enough yet to shock the market. Sticky inflation is just beginning it can take a year or more to start to come down.
So the reality is that I am more bullish on the stock market than the bond market is! They believe the next recession is going to start soon, which I agree with, and it will be deep, which I agree with. But we disagree on the timing.
No matter whose timing is right, we have yet to even come close to the pain of 2023.
How do we make money?
I'm shorting home builders (like the ETF XHB and individual stocks like LEN and PHM) and will look to short autos (GM and F) in the near future. Down the road, I will short consumer discretionary stocks (I also want to short some of these because China is also going into a recession. So short WYNN and Tiffany and SBUX.
Good bear trading,
Courtney Smith
P.S. One of the things you get when you join the Stock Navigator is my daily Macro Report. This unique video briefing outlines what is going on in the world and how you can make money from it. I just got this yesterday: "
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