Gyroscopic Investing

MangoMan wrote:

buddtholomew wrote: As I've said before I manage duration to 5.6 years. If interest rates rise by 1%, I expect LTT to fall by approximately 17% and CD's/Cash to gain a minimal amount. Looking at the FI portion of the portfolio as a whole, I only expect to lose approximately 6%. Fixed income duration will fall and I will be required to purchase additional LTT's to restore the duration to 5.6 years.

Sorry if I missed the explanation, but how did you decide on 5.6%?

Reub wrote: It sure seems that when the four different lines on the chart compress is when we have our stock market crashes. Am I wrong? Thankfully the lines seem relatively spaced right now.

Reub wrote: So this time it's different? I doubt that!

This chart through 2014 shows 1998’s, 2001’s, 2004’s, 2008’s, and 2011’s recessions in Japan all occurred without an inverted yield curve, even though Japan’s former history also showed the yield curve to be a great recession predictor.

Instead, since the mid-1990’s a flattening of the curve as opposed to a full inversion was all the warning provided for an impending recession.

A History Lesson for the Fed

So, what happened in the mid-1990’s to make Japan’s yield curve inversion no longer a recession predictor?

The Bank of Japan started lowering discount rates toward zero in an effort to counter deflationary forces; sound familiar?

20 years later Japan maintains its short term discount rate below 1% and the Federal Reserve Bank of the United States also has now adopted a similar very low discount rate policy “indefinitely”?.

The inverted yield curve may have worked well during times of inflation, but during times of deflation and low short term interest rates, its predictive power falls apart.  Instead investors should watch for just a flattening of the curve instead of an outright inversion as occurred in all the Japanese recessions since the mid-1990’s to warn of the U.S.’s next recession.

Given the extremely low interest and inflation rates, deflation remains the key risk to your investment portfolio as we outlined in our March Newsletter where we discussed one way to take advantage of deflation through the U.S. Dollar (NYSEARCA:UUP).  Its price is putting together a bullish long term chart pattern and should benefit as deflation continues.  We also discussed the implications a stronger dollar would have on commodities such as gold (NYSEARCA:GLD), which has already seen a 5% decline since due to U.S. dollar strength.

History teaches us that with such low interest rate policies, the U.S. is likely not to see an inverted yield curve again, but this does not mean recessions should not be expected as Japan has had five of them since adopting their version of ZIRP, dealing with deflation for over twenty years now.

TennPaGa wrote: Per the thread title... I guess I've never looked before, but I will admit to being surprised at how yields have generally not been that different for different maturity periods.  Plot below is for 1, 5, 10, and 30-year treasuries.

Reub wrote: It sure seems that when the four different lines on the chart compress is when we have our stock market crashes. Am I wrong? Thankfully the lines seem relatively spaced right now.

stone wrote: I'm wondering whether that was just a pre-QE phenomenon though. Perhaps now we have had QE, we won't be getting any meaningful short term interest rate rises for a long time to come? Crashes now will just happen for non-interest-rate-related reasons.

stone wrote: Instead, since the mid-1990’s a flattening of the curve as opposed to a full inversion was all the warning provided for an impending recession.