Forget 1999, Party Like It's 2017
- In 2000, the yield curve turned negative and so did the Nasdaq.
- In 2017, the yield curve is still positive despite the weak economic data.
- The yield curve has been a reliable recession indicator for the past seven downturns.
There is negative sentiment regarding the economy and the SPDR S&P 500 (SPY) and Nasdaq. Many are saying that we should party like its 1999. Despite the bearish sentiment, we are not there yet.
The average bear market lasts approximately five years. We are currently in the eighth year of the bull market, and more bears are coming out of hibernation. Many are calling for a crash or how a recession is on its way very shortly. This sentiment is appropriate as people remember the gloomy days of the 1987 crash, the Nasdaq bubble popping, and the recent real estate crash.
Many people refuse to look at the yield curve when stating that the economy will slow down. The yield curve accurately forecasted the previous seven recessions, and it should be scrutinized by the investing community. In my previous article, I described the yield curve. "In a growing economy, long-term rates are greater than short-term rates. When short-term rates are higher than longer dated interest rates, this means that there is stress in the economy. Banks usually invest in long-term illiquid assets, and they fund their operations by short-term liquidity. This system only functions when short-term rates are less than longer term rates. If short-term rates do go higher, then the banks lose money."
In April 2000, Alan Greenspan raised the fed funds rate to 6.00%, and the 10 year traded at 6% as well. The yield curve (fed funds rate minus the 10 year) turned negative after May, and the spread at the end of the year was -100 basis points. During this time, the Nasdaq topped out shortly before Greenspan raised the short end to 6.00%. The maestro popped the Nasdaq bubble to purge the financial system of excess speculation. Although the Nasdaq crashed, the economy still had strong job growth. Despite this strong growth, the yield curve foreshadowed the 2002-2003 recession.
Ben Bernanke raised the Fed funds rate to 5.25% in June 2006, and the 10 year traded at 5.25%. Shortly after, the yield curve turned negative. Despite the inverted yield curve, the stock market rallied for approximately a little over year until the fall of 2007. The stock market began its major decline, and a recession followed in December 2007 to early 2009. Once again, the yield curve foretold the looming U.S. recession.
Currently, the fed funds rate is at 1.00% and the 10 year is trading at 2.39%. The spread is positive, and this indicates that there will probably not be a recession anytime soon. Bears make decent points when they state that the fundamentals aren't strong. Some examples include gasoline demand isn't strong, slow loan growth, a lackluster GDP, and many more.
As long as banks can borrow cheaply and lend at a higher rate, the economy will continue to grow albeit the rise in pessimism. For those that want to party like its 1999, they may need to patiently wait for a few more years.
This article was written by
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