Yield-curve inversion hits widest level in 22 years
What is it?
There are factors outside of equities that help us understand what’s going on with stocks. By keeping an eye on the currency and bond markets, we can see how those aspects may affect the stock market.
“Interest rate risk is the potential that a change in overall interest rates will reduce the value of a bond or other fixed-rate investment.”* This is important for bond markets as the Fed is raising interest rates.
“Currency risk, commonly referred to as exchange-rate risk, arises from the change in price of one currency in relation to another.”** This is happening in the currency markets. Stocks are quoted in U.S. Dollars so we do not see a change in the asset prices as the value of the dollar fluctuates.
Why does it matter?
A normal yield curve has an upward sloping shape. As you are increasing the term of a debt instrument, interest rates should also go up. This makes sense since an issuer/investor of debt is facing more risk since the money will be tied up for a longer period of time, and should be paid more to take that risk.
An inverted yield curve means that short-term rates are higher than longer-term rates. Currently, the most followed yield curve is inverted.
“The yield curve between the 2-year and 10-year Treasury notes has inverted to its widest point in 22 years, dating back to September of 2000.”***
“Historically, extended inversion periods tend to foreshadow future market downturns.”***
With this information, we believe that the bond market is not predicting a favorable economical environment. We will keep that in mind as we make our investment decisions.
Picky Investors
What is it?
“Even as stocks rallied in July, demand for stocks was sluggish. Investors were defensive and largely avoided thematic ETFs.”****
Some investors are buying into the rally within a downtrend. Doing so would be more of a short-term move if the downtrend continues. Others may be taking a longer-term approach and choosing to invest for years down the road with the anticipation of higher future values.
Why does it matter?
Investors seem to be making moves but with lower conviction than they once did. I say that since many of the buy-side trades have been for more defensive sectors. If people were investing heavily in more volatile stocks than the S&P 500 then that could be taken as a sign of confidence. As investors avoid taking large positions in riskier assets, we believe they are not willing to risk a further downturn. However, by investing in less volatile stocks such as defensive ETFs, investors can be involved in the rally with less downside risk than being in a volatile portfolio.
Other articles we found interesting this week:
Retail investors perceive stocks, bonds to be more arcane than crypto
Cybersecurity Company ZeroFox Goes Public
Dollar at risk of falling further
Current 401(k) portfolio
Our last portfolio reallocation: 5/19/2022.
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Sources:
*James Chen. “Interest Rate Risk”. Investopedia. 12/31/2021.
**James Chen. “Currency Risk”. Investopedia. 5/25/2022. https://www.investopedia.com/terms/c/currencyrisk.asp
***Jason Capul. “Yield-curve inversion hits widest level in 22 years”. Seeking Alpha. 8/4/2022. https://seekingalpha.com/news/3867254-yield-curve-inversion-hits-widest-level-in-22-years?utm_source=from.flipboard.com&utm_medium=referral
**Christine Idzelis. “Stocks rallied, but July ETF purchases showed ‘lack of conviction’ as thematic funds bleed”. MarketWatch. 8/4/2022. https://www.marketwatch.com/story/stocks-have-rallied-but-july-etf-buying-showed-lack-of-conviction-as-thematic-funds-bled-11659641915
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