Fullermoney: Watch the Yield Curve Indicator

One of the most incisive thinkers in the investment field is David Fuller who runs the Fullermoney service from London and provides daily written and podcast commentary. I have been subscribing to the service for more than 20 years and consider it part of my staple investment diet, particularly also for its truly global approach. I am not an agent for David, but please visit by his site to get a feel for his excellent commentary.

The paragraphs below from Monday’s Fullermoney report are particularly topical at this juncture in stock markets.

Veteran subscribers will recall a remark often used on this site: Bull markets do not die of old age - to which I will add, or warnings by Roubiniesque economists. Instead, they are assassinated - usually by central banks.

So how many rate bullets does it take to fell a bull?

You may not be surprised to hear that there is no precise answer, because it depends mainly on sentiment and liquidity. We know when central banks start to reduce liquidity, or at least increase its price, but we do not know precisely when that will affect sentiment adversely.

We know that a few central banks have commenced an incremental tightening of rates. However, we cannot know how aggressively they will act or when other central banks will follow their lead, because they do not know themselves.

Recently, some big guns from the investment management and hedge fund industry concluded that stock markets were ripe for a correction. I was of a similar view. However, markets seldom dance to countertrend tunes for long, and with but a few exceptions we have seen little more than slightly larger reactions and more sideways ranging recently.

The DJIA’s new recovery high today [Monday] is not exactly the stuff of corrections, unless it is instantly and dramatically reversed. Meanwhile, I would back the bull trend. After all, we have seen some mean reversion recently, narrowing overextensions relative to 200-day moving averages. There is also the not insignificant matter of the biggest monetary reflation in human history, and there is no hyperbole in that description.

Stock market indices would have to break beneath their most recent reaction lows to question further the overall outlook for sideways to higher ranging.

Meanwhile, note also the still widening spread between US 10-year yields over 2-year yields, otherwise known as the Yield Curve, on this historical chart. It is still rising, indicating to me that quantitative easing continues. The time to start thinking about closing long portfolios in anticipation of the next bear market, I suggest, will be when the Yield Curve next inverts by moving below zero. However the lead was so early last time (early 2006) that some of us became complacent about it.

Click to enlarge:

Source: Fullermoney.com, November 10, 2009.

Comments

[enigmaman:]

How much more can the Yield spread continue, looking at the chart it appears current spreads are about where the previous two yield spreads topped and rolled over. They both topped a few years before the markets corrected in 1999 and 2008. Yield curve is a good leading indicator for a bull rally but a lagging indicator for a bear because the markets still rose as the yield spread started to compress, though the lag time has shortened dramatically. Any conjecture on this most recent yield curve spread pattern going forward? What can cause it to roll over?

Nov 11 06:27 AM

[The Simple ...:]

Thinking through this, yield curve flattening would have to happen through (1) rising short maturity yields, (2) falling long maturity yields, or (3) some combination of 1 and 2.

#1 would happen by central bank tightening, #2 primarily through market action. The Fed has repeatedly told us they will not raise rates any time soon, and the market is pushing long maturity yields upwards incrementally, any QE notwithstanding.

My takeaway from that is there is nothing on the horizon which would suggest a flattening yield curve in the US. Of course, we have been surprised by events with some regularity, so stay alert and don't hesitate to close any positions quickly.

On Nov 11 06:27 AM enigmaman wrote:

> How much more can the Yield spread continue, looking at the chart
> it appears current spreads are about where the previous two yield
> spreads topped and rolled over. They both topped a few years before
> the markets corrected in 1999 and 2008. Yield curve is a good leading
> indicator for a bull rally but a lagging indicator for a bear because
> the markets still rose as the yield spread started to compress, though
> the lag time has shortened dramatically. Any conjecture on this most
> recent yield curve spread pattern going forward? What can cause it
> to roll over?

Nov 11 10:49 AM

[bobbybutte:]

I enjoyed this as aperson who is financially independent i am a tough judge of articles but this one is spot on well done

Nov 11 11:02 AM

[ryanclarke:]

The yield curve says little as to whether the banks will lend or not ... just that if they do it is to their benefit. In these times I would pay closer attention to the Federal Flow of Funds ... which is here www.federalreserve.gov... ... never in modern history (since 1975) has total household debt increased by less than 1% as it did in 2008. Even in 82 and 92 total household debt increased by 5% ... which tells me the banks could care less about the yield curve in this present economy.

Nov 11 02:09 PM

[SeekingTruth:]

Prieur,
Relative to your note of complacency circa 2006:

Would be good and useful if some one produced a chart noting the lag times for start of the corrections following the start of an inverted yield curve.
I saw one or two of these charts in the 70's and early 80's and it turned out to be fairly predictive of the actual results.
Thanks for any and all efforts in this regard, and for all your superb work.

Nov 11 02:49 PM