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Yield Curve Inversions Are Rare: A Historical Review Across Dissimilar Asset Classes (Part II)

yield curve indicator
Authored By: Mason Stark, Head of Wilshire Phoenix Asset Management (WPAM)

  • We believe investors should be mindful of government monetary policies more than just rely on certain signals.
  • The relative returns of the USD and gold may be explanatory versus each other, as opposed to the influence of any yield curve inversion in and of itself.
  • Investors that have been stretching risk tolerances in search of income should note that ‘riskier bonds’ might not participate in future rallies.

In our prior piece, we focused on how equities market performed after historical yield curve inversions. We now look at how several other asset classes fared post-inversion, beginning with gold.

The last memory is usually the strongest, and the last time the curve inverted, gold took off to the upside in a big way. Recent strength in precious metals suggests market participants are anticipating this performance again. The era of Quantitative Easing (QE) is leading to fears of a global currency devaluation race in the fiat exchange system. Gold can act as a store-of-value to protect against these policies for investors, however, it is important to note that the late 90’s case took a few years before gold began to appreciate, and the late 80’s period did not see any meaningful rally. Therefore, we believe investors should be mindful of government monetary policies more than just rely on the ‘curve inversion signal’ that occurred several months ago.

Source: Bloomberg. (Green Line denotes 30 Year – 3 Month Libor Spread, Yellow Line denotes Continuous Gold Futures Price, Red Lines denote the start of Yield Curve Inversions)

The U.S. Dollar

There is a common view that economic weakness leads to U.S. Dollar (USD) strength, as investors flock to the relative safety of the world’s reserve currency as a store-of-value. This view suggests a positive outlook for the USD after yield inversions. That was the case in the late 80’s, and it continued to tack onto its relative strength in the late 90’s, but the last occurrence at the end of 2005 did not produce the same result. In fact, if you toggle back and forth between the below and the above charts, it appears that the relative returns of the USD and gold are explanatory versus each other, as opposed to the influence of any yield curve inversion in and of itself.

Source: Bloomberg. (Green Line denotes 30 Year – 3 Month Libor Spread, Blue Line denotes U.S. Trade Weighted Broad Dollar Index, Red Lines denote the start of Yield Curve Inversions)

Broad Commodities

Most of the current commodity indexes are heavily weighted towards energy and oil. This is likely the case because oil is one of the most heavily traded futures contracts in the commodities market. Due to this, our practice is to use a wider metric for determining overall commodity trends, and the Bloomberg Commodity Index (BCOM) fits that purpose (with a closer balance between energy, metals and agricultural commodities). Interestingly, broad commodities performed quite well as an asset class when the yield curve inverted in the past. This performance has not been immediate, for instance in the 90’s, however, generally each period showed a positive return for broad commodities after an inversion.

Source: Bloomberg. (Green Line denotes 30 Year – 3 Month Libor Spread, Light Blue Line denotes Bloomberg Broad Commodity Index, Red Lines denote the start of Yield Curve Inversions)

High Yield Corporate Bonds

There has been a nearly 40-year rally in bond prices since the early 80’s. The following might be intuitive, but if yield curve inversions forecast difficult economic environments ahead, then high yield corporate bonds might not be a strong asset class for a while. As you can see from the chart below, when the yield curve inverts, prices for these bonds either halt their rise, or decline at some point thereafter. Most of the talk as of late is about negative interest rates across the globe, and some even believe the U.S. could join the rest of the world on that front. This is the first yield curve inversion during the era of aggressive monetary policy actions such as QE, so nothing seems impossible even if improbable. However, it’s important to note for those that have been stretching risk tolerances in search of income, that riskier bonds might not participate in future rallies even if U.S Treasury rates do go negative. The forces of economic growth and risk appetite might outweigh the pull of the inverted U.S. Treasury curve, and possibly future negative U.S. interest rates.

Source: Bloomberg. (Green Line denotes 30 Year – 3 Month Libor Spread, Orange Line denotes Bloomberg Barclays Corporate High Yield Index, Red Lines denote the start of Yield Curve Inversions)

In conclusion, we believe historical reviews of key economic events, such as this yield curve inversion analysis, may be useful to frame one’s portfolio positioning, risk appetite, and thought process in an increasingly complex financial environment.

“History doesn’t repeat itself, but it often rhymes”
-Mark Twain

In studying the financial markets, history can be a valuable tool to build a thesis, as such is often the case in dissimilar fields.

About the Author

Mason Stark is a Partner of Wilshire Phoenix and is the Head of its Asset Management Group (WPAM). He has over 25 years of experience in the hedge fund industry and capital management. Mason began his career at Granite Capital as an Equities Analyst and Trader, before leaving as the Head of Granite’s Trading in 2000 to join Ramius Capital Group (RCG). As Managing Director at RCG, Mason built the Hedged Equity Group, managing more than a billion of gross invested capital. In 2010, Mason, and two other original RCG members, founded Ballast Capital, LP, and guided it through a successful seed round led by Investcorp. From Ballast, Mason went on to numerous appointments, including Ambi Advisors and wealth management with The Healy Group. Mason is a graduate of Sarah Lawrence College with a B.A in Economics and International Relations. Mason has also obtained the Series 7, 56, 63 and 65 Licenses.

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