The yield curve has incredible predictive power. An inverted yield curve has predicted every major economic downturn over the last 50 years and has always foreshadowed a profits recession. I first became cautious on the markets over the holidays in late 2006 when the yield curve inverted. Although it took 18 months for disaster to strike it paid off as I avoided the declines in the major indices entirely. What we’re seeing now is a very different scenario, however. The yield curve has once again normalized and currently predicts a very low probability of a recession 12 months out.
Unfortunately, a normalized yield curve does not carry the same predictive power that an inverted yield does. The following charts show the long-term and current yield curve. Although a normalized yield curve does not equal economic recovery I do believe the economy will be in substantially better shape one year from now than it is today.
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Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
