Lag Of the Curve, May Strike An Investment Nerve

Have a look at this chart:



What does this show? It shows something very interesting, and that you should be aware of as an investor. Above is a comparison of the 3-month, 5-year, 10-year, and 30-year treasury yields beginning in 1994.

What is its significance? The majority of the time short and long-term yield either rise or fall with high correlation, in tandem. However, there are rare periods when they do not, and currently we are experiencing one of those periods.

A good indicator of a recession, or large stock market correction has been when short-term yields rise above long-term rates. This is technically called an "inverted yield curve". Before every one of the last six recessions there has been an inverted yield curve, occuring on average about 3-6 months before the beginning of the recession.

What is shown in the charts above is that there has been strong flattening of short term yields, while the increase rate of longer term yields has slowed. Now have a look at the chart below:



If you look at at the end, where we currently are, it shows the difference of the 10 and 3-month at the top of the chart (between the 2 dashed horizontal lines).
Now look at what happened after the last time yield differences where at that point. There was a sharp drop down to the circle, the circle is the yield curve inversion.

From history, and the chart above, we can say that the next phase is dropping of long term yields and inversion of the yield curve. At the current rate, and historical trends, we can expect another yield curve inversion to occur within 1-3 years, and another recession in about 4-5 years based on current yield curve analysis.

Currently, this is what we believe will be a large catalyst to the short-term bond bubble (we are currently still in) burst we are expecting. Therefore, as short term yields rise and the yield curve begins to invert, inflation following or floating rate investments (floating bonds, floating bond funds, etc..), should do very well in the years to come. Also, other analysis of ours suggests long-term bond funds in general should do very well in the coming years.