"Kee" Points with Jim Kee, Ph.D.

  • A strong year so far
  • Another yield curve story?


A strong year so far

You have probably heard by now that the first quarter of this year was the best quarter for the U.S. stock market (S&P 500) since 2009, which is kind of remarkable given the doom-and-gloom talk of Brexit, China trade deals, and a possible U.S. recession. Of course, a lot of the market’s move was probably just a rebound from the deep sell-off that occurred during the fourth quarter of last year. Nevertheless, it reinforces the caution against being out of the market during volatile times. I think it is a mistake to get too hung up over the media’s obsessions with pullbacks, corrections, bear-markets, and recessions. Plunges tend to be followed by rebounds, but you never know how long a decline will last, which means you never know when a rebound will begin or how long it will last. In my opinion, it is much more helpful just to remember that, “the market goes up and down.” As flippant as that sounds, people tend to temporarily forget the normality of ups and downs during sell-offs. Try this: the next time there is a big market sell-off (it won’t be long), instead of thinking about it in terms of some ominous sign, say to yourself instead, “Well, the market goes up and down.” I am confident that it will make it much easier to stay with your investment plan, which in-turn will make it much more likely that you reach your investment goals.

Another yield curve story?

I think I had promised that there would be no more commentary on inverted yield curves, but I came across a study that I think Kee Points readers will find interesting. In the most recent issue of Business Economics, which is the journal of the National Association of Business Economists (NABE), a new framework was proposed to predict recessions using short-term rates (the federal funds rate) and 10-year Treasury yields. The federal funds rate is the rate targeted by the Federal Reserve (specifically, the Federal Open Market Committee or FOMC), and it is the interest rate at which depository institutions charge one-another for funds they hold on reserve at the Fed (i.e., “federal funds”). The rate that the borrowing institution pays to the lending institution is negotiated between the two banks, and the federal funds rate is the weighted average of all of these types of negotiations (Federal Reserve Bank of St. Louis). The NABE article discusses a “fed funds rate/10-year threshold” as follows:

“In a rising fed funds rate period, the fed funds rate crossing/touching the lowest level of the 10-year yield in that cycle is a prediction of an upcoming recession.”

According to the authors, the average lead time between this signal and the onset of recession is 17 months. For example, the current rate hike regime started in December, 2015. If you look at the 10-year Treasury yield from that time on, it follows somewhat of a U-shaped pattern, with the bottom being 1.36% on July 5, 2016. So the question is, when did the fed funds rate, which was zero for seven years, rise above 1.36%? It occurred after the December, 2017 FOMC meeting. That would put the next recession sometime this year (2019). The authors felt that the 2018 tax cut would not affect this call, but that the ongoing tariff/trade war will, primarily by disturbing global supply chains. I think the research is clever, but there is also a tint of Nobel Laureate George Stigler’s assertion that, “If you torture the data long enough, it will confess to anything.” So, as I summarized last week, better to just take a front row seat and wait and see.