Yield Curve and the Next Stock Market Correction

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Doc
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Yield Curve and the Next Stock Market Correction

Post by Doc » Sun May 21, 2017 8:51 am

Given the news coming out of Washington the last several months I began thinking where the best place was to store some "dry powder".

I came up with this FRED Graph that indicates how the yield curve shifts with time. Instead of the more usual presentation of yield vs maturity for different times I used yield vs time for different maturities.

The first chart is for the last five years but going back to some previous 5 yr periods show something unexpected at times.
Image


Lehman & quantitative easing
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2005-2007 Bush 2nd term
Image


Here's a link to the FRED site so you can play with the chart yourselves.
https://fred.stlouisfed.org/graph/?g=dO3l
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Re: Yield Curve and the Next Stock Market Correction

Post by nisiprius » Sun May 21, 2017 9:07 am

Very cool. You can also see a very different presentation of the yield curve flattening on the dynamic yield curve web page at stockcharts.com

Since the idea that a flattening or inverted yield curve predicts recessions has been around for a long time. Wikipedia's article says "Campbell R. Harvey's 1986 dissertation showed that an inverted yield curve accurately forecasts U.S. recessions." Since economists presumably have heard about this, yet economists are famously bad at predicting recessions, I suspect it can't be as simple at all that.

And even if an inverted yield curve predicts a recession, does a flat yield curve predict an inverted yield curve... and does a less steep yield curve predict a flat yield curve?
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Re: Yield Curve and the Next Stock Market Correction

Post by NiceUnparticularMan » Sun May 21, 2017 10:58 am

So we have a "relatively flat" (aka "less steep") yield curve, but not a truly flat yield curve.

I'm skeptical that has much predictive value of a recession specifically.

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Re: Yield Curve and the Next Stock Market Correction

Post by Svensk Anga » Sun May 21, 2017 11:10 am

I went back another recession. The yield curve went flat December 1994. Stocks peaked in early 2000, over five years later, and the official recession started March 2001. And this is supposed to be one of our better signals for market troubles ahead, presumably near-term?

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Re: Yield Curve and the Next Stock Market Correction

Post by lack_ey » Sun May 21, 2017 11:38 am

One of the best indicators, probably. Still obviously not reliable. You have a number of false positives and then delayed reactions or false negatives.

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Re: Yield Curve and the Next Stock Market Correction

Post by MindBogler » Sun May 21, 2017 11:42 am

The yield curve was inverted late January - early February 2000 and remained that way for the 6 months leading up to the tech bubble burst. This data, when combined with a PE10 near 40, was a signal that something was very wrong. Even John Bogle was de-risking. Fast forward to November 2006 and the yield curve is inverted again. This time, though, it takes a full year until October 2007 before the market crashes. Yield curve inversions have been fairly accurate at predicting forthcoming recessions but recessions are not accurate at predicting the manner, timing or magnitude of stock declines. Even if it could, a recession doesn't guarantee a significant stock decline.

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Re: Yield Curve and the Next Stock Market Correction

Post by Doc » Sun May 21, 2017 11:55 am

My purpose of this exercise was not to address the flatness of the yield curve or predict the next recession. Rather is was to try to determine the duration of any "dry powder" I might chose if I decide the current market/political/economy conditions dictate any dry power at all.

As an example I currently hold a ~2-9 year Treasury (real/nominal mix) ladder with some double and some missing rungs. Three rungs are filled with 1-3 and 1-5 funds not actual notes. When/if I decide to buy actual notes with these funds what maturity should I buy. Before I start another thread altogether with this comment I am unlikely to move the overall duration much at all if any. More like do I want a three and a seven or just 2 fives?
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Re: Yield Curve and the Next Stock Market Correction

Post by AndrewXnn » Sun May 21, 2017 1:00 pm

Thanks for sharing this information.

The yield curve is obviously tighter than it has been for many years.
However, that does not mean the economy is about to crash or a large correction is near.
Looking over the charts, it appears that the yield curve currently resembles 2004 (more or less).
This does not mean the next few years will resemble 2005-2007.

It's only with time that we will know how the markets will evolve.
I understand that the Federal Reserve was concerned about the extraordinary policy
that had been in place from 2009-2015. The plan is to gradual return to a more normal
monetary policy.

Depending on how aggressive one has been, it is probably prudent to adopt a "normal" stance.
I'm not enough of an expert to suggest specific duration.
However, in general short term bonds are safer.
Currently, they are underwater. Not as far underwater as they have been, but still underwater.
By underwater, I mean the real short term interest rates are negative.
Someday, they may approach zero or even go positive.
However, until they do, they are silly to own.

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Re: Yield Curve and the Next Stock Market Correction

Post by Svensk Anga » Sun May 21, 2017 1:05 pm

If the yield curve goes truly flat or inverts, I think you want to go longer term. Ironic, because the short yields would be so high and there would seem to be no term premium. But if the "forecast" recession comes, there will be nice gains to be had on the longer bonds - just what you want for your dry powder.

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Re: Yield Curve and the Next Stock Market Correction

Post by Doc » Sun May 21, 2017 1:33 pm

Svensk Anga wrote:But if the "forecast" recession comes, there will be nice gains to be had on the longer bonds - just what you want for your dry powder.
I don't care about "dry powder" for a recession. A TBM fund would do for that. I'm wanting dry powder to kill the bear in the stock market in case the congress does/does not pass the tax bill, Comey says the Russians are colluding or not colluding with our politicians, the North Koreans miss or do not miss Vladivostok with their next missile test ...

Based on the past bears, would it be better to hold some of the Treasuries I already own as two's or ten's or something in between.

I guess what I'm saying is what is the effect of a stock market tanking on the yield curve rather than what is the effect of a shift in the yield curve on the stock market - a short term flight to quality event rather than longer term macro-economics theory.

Aside, since many of you are finding some use for my charts I'll take credit even if that use is not what I had in mind. :D
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Re: Yield Curve and the Next Stock Market Correction

Post by NiceUnparticularMan » Sun May 21, 2017 1:58 pm

I'm still confused about what we are supposed to be imagining and when.

But if it helps, you can observe that in most cases when the yield curve inverts prior to a recession, it is shorter-term yields going up, not longer-term yields going down. I guess this implies if you are predicting all this is about to happen, you would generally want to move your shorter-term to longer-term. Then when the yield-curve inverted, you could do the opposite (move your longer-term back to shorter-term).

However, you then suggested you didn't want to change your duration. So if you are asking if there is a clever way to benefit from this without changing your duration, my guess is no, for the reason I just gave . . . with that side-constraint, I believe you have likely ruled out the sort of arbitrage you would want to be doing.

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Re: Yield Curve and the Next Stock Market Correction

Post by Chan_va » Sun May 21, 2017 2:11 pm

If I understand right, you are asking the following question.

Given a particular value (PE 10?) of the stock market, is there a bond duration that minimizes the loss function of the portfolio over time period Y?

If you frame it that way, then the answer becomes - no way to know since you have to predict so many things. But like someone else said, if you time a correction, then the answer would be to lengthen your bond duration.

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Re: Yield Curve and the Next Stock Market Correction

Post by Doc » Sun May 21, 2017 2:12 pm

NiceUnparticularMan wrote:However, you then suggested you didn't want to change your duration. So if you are asking if there is a clever way to benefit from this without changing your duration, my guess is no, for the reason I just gave . . . with that side-constraint, I believe you have likely ruled out the sort of arbitrage you would want to be doing.
Say I hold $100k in five year Treasury notes. I sell them and buy $50k of three year notes and $50k of seven year notes. Or maybe I can gleam something from the past data that says I should do the opposite. I have no idea which. That's why I obtained the data.

You could be in the same position if you used funds. Do you trade the that 1-10 fund for a 1-5 plus a 5-10? Did the short end work better in the past crises or did the longer end?

(I spent a little time trying to get the FRED charts to show some kind of price change instead of yield but couldn't figure how to do it without downloading the data and using a spreadsheet. That wouldn't be too hard but I haven't done it.)
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Re: Yield Curve and the Next Stock Market Correction

Post by Doc » Sun May 21, 2017 2:22 pm

Chan_va wrote:If I understand right, you are asking the following question.

Given a particular value (PE 10?) of the stock market, is there a bond duration that minimizes the loss function of the portfolio over time period Y?

If you frame it that way, then the answer becomes - no way to know since you have to predict so many things. But like someone else said, if you time a correction, then the answer would be to lengthen your bond duration.
No I'm looking at what mix of Treasuries would be best if any if an event outside of the "normal" economic trends caused a "flight to quality" situation. Given the national and international news lately I would suggest that such an event is more likely to occur sometime in the near future than it has since Lehman. Of course we didn't get a clear signal before Lehman so we don't have the same situation.

I don't intend to change my overall bond duration just the mix of durations that give me the same overall value.
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Re: Yield Curve and the Next Stock Market Correction

Post by Chan_va » Sun May 21, 2017 2:29 pm

Doc wrote:
Chan_va wrote:If I understand right, you are asking the following question.

Given a particular value (PE 10?) of the stock market, is there a bond duration that minimizes the loss function of the portfolio over time period Y?

If you frame it that way, then the answer becomes - no way to know since you have to predict so many things. But like someone else said, if you time a correction, then the answer would be to lengthen your bond duration.
No I'm looking at what mix of Treasuries would be best if any if an event outside of the "normal" economic trends caused a "flight to quality" situation. Given the national and international news lately I would suggest that such an event is more likely to occur sometime in the near future than it has since Lehman. Of course we didn't get a clear signal before Lehman so we don't have the same situation.

I don't intend to change my overall bond duration just the mix of durations that give me the same overall value.
I see - you are asking if a bond barbell or bullet is better in a flattening yield curve world. The answer would be a barbell. So, adjust your mix to a barbell with the same duration.

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Re: Yield Curve and the Next Stock Market Correction

Post by Angst » Sun May 21, 2017 3:13 pm

Chan_va wrote:I see - you are asking if a bond barbell or bullet is better in a flattening yield curve world. The answer would be a barbell. So, adjust your mix to a barbell with the same duration.
Doc, if this is the case, wouldn't the next question be: Which can move faster - a bear or a yield curve?

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Re: Yield Curve and the Next Stock Market Correction

Post by Doc » Sun May 21, 2017 3:43 pm

Chan_va wrote:I see - you are asking if a bond barbell or bullet is better in a flattening yield curve world. The answer would be a barbell. So, adjust your mix to a barbell with the same duration.
I agree that the question is about a barbell or a bullet but it has nothing to do with the yield curve flattening. It has to do with a flight to quality situation and the is more likely to cause a change in the yield curve not the other way around.
Angst wrote:Doc, if this is the case, wouldn't the next question be: Which can move faster - a bear or a yield curve?
I have no doubt there. I think the yield curve is a turtle compared to the bear. That said if I could get the stock market on the chart it wold be interesting. I don't use FRED for equities but if there is a metric available it might be interesting to add to the chart. One might have to scale it but that can be done.
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Re: Yield Curve and the Next Stock Market Correction

Post by Doc » Sun May 21, 2017 3:47 pm

Ironically I was just finished watching a taped news channel segment from yesterday morning while I was eating lunch. The first thing they discussed was if all the turmoil coming out of Washington would affect the markets. (They never mentioned bonds. Probably above their pay grade since none of them were Bogleheads.)
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Re: Yield Curve and the Next Stock Market Correction

Post by NiceUnparticularMan » Sun May 21, 2017 5:06 pm

Doc wrote:
Chan_va wrote:I see - you are asking if a bond barbell or bullet is better in a flattening yield curve world. The answer would be a barbell. So, adjust your mix to a barbell with the same duration.
I agree that the question is about a barbell or a bullet but it has nothing to do with the yield curve flattening. It has to do with a flight to quality situation and the is more likely to cause a change in the yield curve not the other way around.


I'm honestly pretty confused. Looking at the charts, it appears the pre-recession "flight to quality" largely takes the form of shorter-term rates converging on longer-term rates. I'd guess the explanation is shorter-term bonds are the "quality" asset of choice in these situations.

So you should be modeling a scenario in which something like all sub-10-year rates rise to equal the current 10-year rate. Apparently the "barbell" will work better in such a scenario, which you could confirm for yourself by running models over different mixes with the same duration.

I haven't done that myself, and I would personally want to know what the exit strategy looks like. If you don't cash out, will the barbell be better once short-term rates drop again? Or should you be changing your mix once it is flat?

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Re: Yield Curve and the Next Stock Market Correction

Post by Slick8503 » Sun May 21, 2017 5:35 pm

Admittedly this topic is probably above my pay grade, but doesn't it seem intuitive that the yield curve would flatten, due to the Fed having more control over short rates? The economy/inflation starts to heat up, the Fed tries to moderate that by increasing short term rates, and a recession follows sometime after... Maybe that is obvious and goes without saying. If so I apologize, just trying to learn.

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Re: Yield Curve and the Next Stock Market Correction

Post by TheTimeLord » Sun May 21, 2017 5:56 pm

Doc wrote:Given the news coming out of Washington the last several months I began thinking where the best place was to store some "dry powder".
Wouldn't the long end of the Treasury yield curve be the logical place for those keeping dry powder to hunt Bear?
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Re: Yield Curve and the Next Stock Market Correction

Post by anoop » Sun May 21, 2017 6:00 pm

CR says no recession for 2017 and not even on recession watch.
http://www.calculatedriskblog.com/2017/ ... ssion.html

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Re: Yield Curve and the Next Stock Market Correction

Post by TheTimeLord » Sun May 21, 2017 6:09 pm

anoop wrote:CR says no recession for 2017 and not even on recession watch.
http://www.calculatedriskblog.com/2017/ ... ssion.html
Yeah, given the forecast for S&P earnings it does seem like the most likely scenario but I guess you never known.
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Re: Yield Curve and the Next Stock Market Correction

Post by ralph124cf » Sun May 21, 2017 6:10 pm

Whenever the question of "dry powder" crops up, my answer is "cash". Preferably in an interest bearing brokerage checking account, where it can be instantly be redeployed to purchase any investment.

Your writing seems to be about how to maximize short term returns while minimizing short term risk of different bond fund durations.

My answer is to accept the short term inflationary loss of cash in return for the flexibility of "dry powder" cash.

Ralph

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Re: Yield Curve and the Next Stock Market Correction

Post by Kevin M » Sun May 21, 2017 9:13 pm

Doc wrote:That said if I could get the stock market on the chart it wold be interesting. I don't use FRED for equities but if there is a metric available it might be interesting to add to the chart. One might have to scale it but that can be done.
FRED has a variety of stock market indexes. Here I've added one along with the 10-year and 2-year Treasury yields (daily):
Image

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Re: Yield Curve and the Next Stock Market Correction

Post by Kevin M » Sun May 21, 2017 9:41 pm

Doc wrote: (I spent a little time trying to get the FRED charts to show some kind of price change instead of yield but couldn't figure how to do it without downloading the data and using a spreadsheet. That wouldn't be too hard but I haven't done it.)
Yeah, just looking at yield changes doesn't do you much good. Looking at the chart I shared, we see the 2-year dropping more in yield than the 10-year in late 2008, but we know for a fact that longer-term Treasuries had much larger price increases than shorter term Treasuries then. You obviously have to factor in the duration.

For the last two big stock drops (2000-2002, 2007-2009), probably better to just use Portfolio Visualizer or our backtest spreadsheet, and compare stocks to short-term and long-term (and intermediate-term if you want) Treasury funds. Long-term did best by far in late 2008 (have looked at that many times), and long term did better than short-term in 2000-2002 as we see here: Backtest Portfolio Asset Allocation.

If you want to go further back, and/or look at finer resolution of different maturities, you'll have to do as you said, and convert yields from FRED or some other source to returns.

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Re: Yield Curve and the Next Stock Market Correction

Post by nedsaid » Sun May 21, 2017 9:42 pm

nisiprius wrote:Very cool. You can also see a very different presentation of the yield curve flattening on the dynamic yield curve web page at stockcharts.com

Since the idea that a flattening or inverted yield curve predicts recessions has been around for a long time. Wikipedia's article says "Campbell R. Harvey's 1986 dissertation showed that an inverted yield curve accurately forecasts U.S. recessions." Since economists presumably have heard about this, yet economists are famously bad at predicting recessions, I suspect it can't be as simple at all that.

And even if an inverted yield curve predicts a recession, does a flat yield curve predict an inverted yield curve... and does a less steep yield curve predict a flat yield curve?
The reason that yield curves get inverted is that the Federal Reserve Bank is pushing up short term interest rates to slow down the economy and thus take inflationary pressures out of it. If long term rates actually start to decline, it is a signal from the bond market that recession may well be coming. If long term rates go up with short term rates, the bond market is signaling that the economy is relatively strong and that inflation pressures are continuing to build.

The thing is, the bond market is made up of pessimists. They are sort of the canary in the mineshaft. I also have wondered if the brightest minds on Wall Street are on the bond side of the market and not the stock side of the market. If you want to check the health of a company check on the bonds it has issued and see how the market is treating them. Bond analysts seem to sense trouble before the stock analysts do. Ditto for the economy as a whole. This is one reason I suspect the best minds are on the bond and not on the stock side. Maybe stock people are goofy, wild-eyed optimists. Bond people are more sober realists, they seem to live by Murphy's Law, if something can go wrong, it likely will. I think some bond analysts believe Murphy was an optimist.

Markets try to anticipate the future and also attempt to incorporate all known information. Since markets are built upon expectation, weird things happen when those expectations are not met. So the bond market might signal continued inflationary pressures ahead with a hike in long term rates but the actual inflation might not show up in reality. Or long term rates might go up a bit but not as much as the stock market had feared and I suppose the stock market could actually rally!

What I am trying to say is that the market signals what it thinks will happen but those signals often turn out to be false alarms. Long rates go up on inflation expectations, a couple days later the actual inflation data shows less inflation than feared, long rates fall again and the stock market potentially rallies. If this were not so, then yield curves and the like would be infallible economic indicators. It is the old joke about economists predicting eight out of the last five recessions.
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Re: Yield Curve and the Next Stock Market Correction

Post by jalbert » Sun May 21, 2017 10:39 pm

Inverted yield curves are not just predictive of recessions but contribute to their cause. Banks borrow short and lend long. When the yield curve is inverted, it becomes unprofitable for banks to make loans, which dampens economic activity. It would be incorrect to say that a recession is inevitable in such a situation, hence an inverted yield curve is a rather imperfect predictor of recessions.
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Re: Yield Curve and the Next Stock Market Correction

Post by Valuethinker » Mon May 22, 2017 5:22 am

nedsaid wrote:
nisiprius wrote:Very cool. You can also see a very different presentation of the yield curve flattening on the dynamic yield curve web page at stockcharts.com

Since the idea that a flattening or inverted yield curve predicts recessions has been around for a long time. Wikipedia's article says "Campbell R. Harvey's 1986 dissertation showed that an inverted yield curve accurately forecasts U.S. recessions." Since economists presumably have heard about this, yet economists are famously bad at predicting recessions, I suspect it can't be as simple at all that.

And even if an inverted yield curve predicts a recession, does a flat yield curve predict an inverted yield curve... and does a less steep yield curve predict a flat yield curve?
The reason that yield curves get inverted is that the Federal Reserve Bank is pushing up short term interest rates to slow down the economy and thus take inflationary pressures out of it. If long term rates actually start to decline, it is a signal from the bond market that recession may well be coming. If long term rates go up with short term rates, the bond market is signaling that the economy is relatively strong and that inflation pressures are continuing to build.

The thing is, the bond market is made up of pessimists. They are sort of the canary in the mineshaft. I also have wondered if the brightest minds on Wall Street are on the bond side of the market and not the stock side of the market. If you want to check the health of a company check on the bonds it has issued and see how the market is treating them. Bond analysts seem to sense trouble before the stock analysts do. Ditto for the economy as a whole. This is one reason I suspect the best minds are on the bond and not on the stock side. Maybe stock people are goofy, wild-eyed optimists. Bond people are more sober realists, they seem to live by Murphy's Law, if something can go wrong, it likely will. I think some bond analysts believe Murphy was an optimist.
You should meet some High Yield Bond people ;-). They can be worse than equity people ;-).

On the Sell Side, equity by its nature has to be bullish. You can't push an IPO or a secondary offering without a good story around it. Ditto M&A transactions etc.

And as a Sell Side analyst you have to have some stocks for clients to buy, ideas for the sales force to pedal. It's also a health hazard to issue "Sells" which is why they very seldom do.

Bond people tend to be pessimistic because their upside (as investors) is limited. If all goes well, you get paid your coupons and your $100 at maturity.

It's not so much the quality of the intellect, as the risk-reward spectrum. They are like cancer doctors in a way. If all goes well you are back to where you were before the diagnosis, if it does not...

The ratings agencies are held to not have the best people (at least on corporate credit) because the best people migrate to sell side credit analyst roles or these days to the buy side. Hence the various gibes at ratings agency people in e.g. The Big Short.
Markets try to anticipate the future and also attempt to incorporate all known information. Since markets are built upon expectation, weird things happen when those expectations are not met. So the bond market might signal continued inflationary pressures ahead with a hike in long term rates but the actual inflation might not show up in reality. Or long term rates might go up a bit but not as much as the stock market had feared and I suppose the stock market could actually rally!
It's really gaming what the Central Banks think, rather than what we think. And investors: seeing the flow of money. So what moves the market is that the Fed (or whoever) tightens more/ less/ the same as expected. If inflation is above expectations, then the CB will tighten faster than expected.

It's a game of estimating what everyone else thinks.
What I am trying to say is that the market signals what it thinks will happen but those signals often turn out to be false alarms. Long rates go up on inflation expectations, a couple days later the actual inflation data shows less inflation than feared, long rates fall again and the stock market potentially rallies. If this were not so, then yield curves and the like would be infallible economic indicators. It is the old joke about economists predicting eight out of the last five recessions.
What drives the long end of the curve is the short end, because that drives the cost of finance of inventory at the long end. At least that's what I think is going on, looking back at the 1990s and 1994 in particular.

Also long bonds are thinly traded. Because the buyers are largely insurance companies that need them to hedge liabilities (pension funds as well) eg annuities. They then hold these bonds until maturity.

In the UK the 30 year bond (and the 50) actually tend to trade at a *lower* yield than the 10-20 year bonds, because of this phenomenon. The pension funds and insurance companies buy them for actuarial reasons, and then do not sell them.

The problem, as you can imagine, is even worse with inflation linked bonds-- Indexed Linked Gilts are c. 25% of total UK government debt outstanding.

A complication is the Fed and the Bank of England, ECB are all now big holders of government debt at the longer maturities. That probably has lowered interest rates, whether it will at some point "snap" back is anyone's guess.

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Re: Yield Curve and the Next Stock Market Correction

Post by Doc » Mon May 22, 2017 8:16 am

There are several concepts running together here - maybe more.

1) Stock market "pullbacks" that have people running to Treasuries - short term effect, stock market driven
2) Flat of inverted yield curve that leads to a recession - longer term, Fed driven(?)
3) Fed actions that steepen or flatten the yield curve - longer term, direction depends on whether Fed is fighting inflation or stimulating the economy

For those interested in the recession concept note that the shaded areas in the FRED charts indicate recessions. See chart in Nisi's post.

My question concerns 1) but there's a lot of good stuff here on the other concepts so I'm going to try to keep my mouth shut and let the thread go wherever it goes.
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Re: Yield Curve and the Next Stock Market Correction

Post by Doc » Mon May 22, 2017 10:29 am

Just got off the phone with a Senior Fixed Income Investment Specialist at a major firm.

She said that one of the reasons for the yield curve flattening recently is increased purchases by foreign investors. It's a demand issue that has nothing to do with US markets - equity or FI. So even the European Central Bank can have an effect on US Treasuries. HHmmnn.
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Valuethinker
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Re: Yield Curve and the Next Stock Market Correction

Post by Valuethinker » Mon May 22, 2017 10:43 am

Doc wrote:Just got off the phone with a Senior Fixed Income Investment Specialist at a major firm.

She said that one of the reasons for the yield curve flattening recently is increased purchases by foreign investors. It's a demand issue that has nothing to do with US markets - equity or FI. So even the European Central Bank can have an effect on US Treasuries. HHmmnn.
Interesting, and thank you.

I guess the ECB buying bonds drives down Eurozone yields. That drives investors into other markets.

What do they do about the currency risk? I am guessing they take it on the chin (assume the risk) because the cost of the currency forward would cancel out the gain on higher yield in the US Treasury security? However whilst that may be true in equilibrium it may not happen quite like that dynamically, so maybe you can still hedge the currency.

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Re: Yield Curve and the Next Stock Market Correction

Post by Valuethinker » Mon May 22, 2017 10:48 am

Doc wrote:There are several concepts running together here - maybe more.

1) Stock market "pullbacks" that have people running to Treasuries - short term effect, stock market driven
Not sure how to price those. Probably they occur-- stock market less attractive short term, so investors move into bonds.
2) Flat of inverted yield curve that leads to a recession - longer term, Fed driven(?)
8 of the last 5 recessions as the joke goes ;-). Beware though because we are in the land of the "post (post) modern recession". In other words, recessions are no longer caused by Fed tightening (they were not in 2000-03 nor in 2008-09) and monetary policy has diminished efficacy against economic slowing.

In other words, we are all Japan. Eurozone is the next Japan, perhaps, but we are all looking very Japan like. What happens in Canada (and possibly Australia and NZ) will be instructive: if there is the asset bubble "pop" I think there will be (housing markets) then what the Central Banks do (and whether it has any effect) will be interesting.
3) Fed actions that steepen or flatten the yield curve - longer term, direction depends on whether Fed is fighting inflation or stimulating the economy
See above. That may not matter anymore.
For those interested in the recession concept note that the shaded areas in the FRED charts indicate recessions. See chart in Nisi's post.

My question concerns 1) but there's a lot of good stuff here on the other concepts so I'm going to try to keep my mouth shut and let the thread go wherever it goes.

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Doc
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Re: Yield Curve and the Next Stock Market Correction

Post by Doc » Mon May 22, 2017 11:00 am

Been perusing my charts. Added the Wilshire per Nisiprius but decided it was better to just take a particular date and go to that part of the chart.

Sooo I looked at the jump across the curve in last quarter 2016. It wasn't the December FOMC meeting it was the presidential election. :o

Darn, I was hoping for a jump in Intermediate T's after next months meeting. I have a hole in my ladder at 8 years that I'd like to fill.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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Re: Yield Curve and the Next Stock Market Correction

Post by nedsaid » Mon May 22, 2017 11:17 am

Valuethinker, I have been very impressed with your posts, depth of knowledge, and economic commentary. Do you write for The Economist? :wink: Seriously, your posts show a lot of knowledge.

Actually, I took nine credit hours of economics in college and have a Bachelors' Degree in Business. I knew a lot of small businessmen and learned a lot from their stories about business. Also having investments gave me a lot of incentive to follow business, markets, and the economy. Amazing what one can learn. I am not a trained economist. Just keep my eyes and ears open.

Again, good comments and analysis.
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Re: Yield Curve and the Next Stock Market Correction

Post by robertalpert » Mon May 22, 2017 7:45 pm

Some rules of thumb (from a book about yield curves by Deborah Weir)

Economic Trends (treasury yields)
3_month > 10_Year Sell
3_month > 30_Year sell
(10_year > 30_year) sell

These become actionable sell criteria when combined with increased quality spreads (AA to junk) moves from the 3% normal spread toward 7% spread.

Don't know how well this works in practice; but these were the observations that Deborah Weir wrote about.

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Re: Yield Curve and the Next Stock Market Correction

Post by Gene S » Tue May 23, 2017 4:53 pm

Doc's charts in the first post are nice, but I still like the yield spread curve. I am just not too sure about its ability to predict recessions after a long period of zero bound short-term rates. The yield curve was a poor predictor of recessions during the period from 1932 through the late 1950s. Zero bound and ultra low short-term rates during this period were not enough to prevent the US economy from going into several recessions. That is why we had quantitative easing during the 2009-2015 period when short-term rates were zero bound. The point is that it might be better to watch the trend in the long-term rates or the trend in the yield spread in addition to the magnitude or level of the yield spread.

Image

The short-term rates on the chart are from 3 Month Treasury, Constant Rate (GS3M), 3 Month Treasury Bills Secondary Market Rate (TB3MS), Yields on Short-Term US Securities: Three to Six Month Treasuries (M1329AUSM193NNBR), and New York Commercial Paper Rates (M13002US35620M156NNBR) that was converted to 3-6 month treasury rates by the regression equation = 0.9396(Commercial Paper Rate) - 1.0316, R² = 0.9237, which is good enough for government rates.

The long-term rates are from 20-Year Treasury Constant Maturity (GS20) with the average of 10 year and 30 year rates to fill in the gap of missing 20-year rates, Yield on U.S. Treasury Bonds with maturity over 10-years, Fed. Res. H15 data (I can't find this series on the FRED website anymore. It was also removed from the economagic site. hmmm...that's interesting. An alternative is to use the long-term government bond yields listed in the Stock, Bonds, Bills, and Inflation Yearbook.), Yield on Long-Term United States Bonds for United States (M1333AUSM156NNBR), and Long-Term interest rates from Shiller's website, where the quarterly data was converted to monthly data.

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