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Concerned about the yield curve? Find out what to do when recession hits…

by , 22 August 2019
Concerned about the yield curve?  Find out what to do when recession hits…
Markets have been incredibly skittish over the last week.

And, while there are many reasons for concern, one of the main issues driving share prices lower is fear over the “inverted yield curve”.

If you skim the financial news, you'll see headlines like:

“Yield curve inversion hammers US small banks”

“Bond market yield curve inverts, signalling Fed may be too slow to cut rates, risks recession”

“Inverted Yield Curve: Is It Time to Worry Yet?”
 
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What’s going on and why is everyone so panicked?
 
The yields, or rates of interest, which are paid on the 2-year and 10-year US Treasury notes inverted for the first time in more than 12 years. 
 
What does this mean?
 
Usually, you would expect longer-dated bonds to pay you more money or a bigger “coupon”. You’re essentially lending the US government cash for 10 years and, because the longer someone else has your money, the higher the risk of something going wrong, you would expect to demand MORE interest as compensation. 
 
In a normal world, you as the investor would want MORE interest when lending the US government money for 10 years than you would for lending them money for 2 years. 
 
This is no longer the case. Mainly, because investors now believe that, in the long run we’ll be fine, but in the short run… Things are going to get dicey. As such they’re demanding more interest on investing money for 2 years than for 10 years!
 
Is this a valid concern?
 
If you do the math, and go back 12 years, you’ll realise the last time the yield curve inverted was just before the 2008 market crash.
 
History tells us an inverted yield curve, although not ALWAYS correct in predicting a recession, has predicted every recession since the 1970s. 
 
Put another way: All recessions first show an inverted yield curve, but not all inverted yield curves result in recession. 
 
So, I’m not saying global markets WILL come crashing down soon, but the inverted yield curve tells us we should be prepared.
 
If you look at other geo-political stories: The US-China trade war; Brexit; Italy’s fiscal showdown with the EU and the political unrest in Hong Kong…
 
I believe it would be prudent to take this yield curve inversion seriously. I believe you should be looking at ways to protect your funds. 
 
So, what should you do if a recession comes and markets crash?
 
Firstly, do not panic! 
 
Prepare yourself. 
 
Many investors panic and sell during market crashes and end up selling good quality stocks at horrible prices. They then need to buy them back later at a higher price when the dust had settled. Unless you are close to retirement, a market crash is a HUGE buying opportunity.
 
If you have a portion of your funds allocated to an equity linked investment, and it is part of long-term plan which does not involve buying and selling actively, then you should be prepared to stick to your plan. 
 
Either change your plan now, while prices are high, or prepare yourself to ride through the noise of a crash. You should be comfortable in the knowledge that you are a buy and hold investor, with a firm hand, and that your asset allocation is correct. 
 
If you are not comfortable with how you’ve distributed your wealth across the risk spectrum. Or if you’ve been slack on implementing a correctly weighted portfolio. Or if you’re unfamiliar with the concept of an asset allocation, I would highly recommend contacting a financial planner to assist you. If you’d like to talk to one of our wealth managers feel free to contact us on support@randswiss.com.
 
Mostly, I want you to change the way you view market crashes. I want you to think about a market crash as Black Friday for shares rather than Black Monday.
 
It’s a time when huge, high-quality, blue chip stocks are oversold and you get to buy them at a MASSIVE discount.
 
Then when the panic is over, and everyone realises it’s not the end of the world, these stocks will start going back up again and you’ll be sitting pretty having bought them at such a discount.
 
But how can you prepare ahead of time?
 
If you’re planning on holding stocks through the crash you could start to shift money into high-quality, high-dividend paying stocks. When the market crashes many blue-chip shares continue to pay dividends and return money to shareholders.
 
For example, Proctor & Gamble (PG) is a company we currently hold in our offshore managed portfolios. It’s paid a dividend ever year for the last 128 years.
 
Let me say that again. Procter & Gamble has a dividend paying streak of 128 years! This company has paid dividends 19 years longer than South Africa has been a country. 
 
It’s seen the ups and downs on the market for over a century. This is the kind of stock I want to be holding when the trouble starts. If you’d like to find our more about our managed portfolio, again you can send an email to support@randswiss.com
 
These types of defensive stocks can be found in industries like utilities, health care and consumer staples. They’re companies which will perform well during recessions but will tend to underperform the market during bullish cycles.
 
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Many prominent asset managers have started to see appeal in the yellow metal. 
 
Legendary emerging markets investor, Mark Mobius yesterday said, “I think you have to be buying [gold] at any level”.
 
He went on to say, “Gold’s long-term prospect is up, up and up, and the reason why I say that is money supply is up, up and up."
 
During a recession, central banks lower interest rates to try and jump start the economy again. In a low interest environment, gold tends to perform well as people shift cash from their bank accounts, which no longer pay good interest, into assets like gold which they perceive as safer. 
 
Considering we now have $16 trillion worth of negative yielding debt globally, many investors looking to protect the value of their investment portfolios will opt for gold instead of these negative yielding bonds. 
 
Buy structured products
 
For me, one of the best recession-proof investments is still a structured product. To this day I have not found a better hedge against market risk. 
 
They give you downside protection while still letting you participate in market upside.
 
So, when markets go down 40% and you’re sleeping easy knowing you’ll get a guaranteed 5% positive outcome, all while not giving up your market linked upside, you’ll be thanking your lucky stars you read this article. 
 
My colleague, Viv Govender has written extensively on the topic of structured products and you can find his most recent article here.
  
Christo Krog,
Analyst, The South African Investor
 
P.S.  There are even BIGGER gains to be made betting on gold stocks. In fact, last month in the South African Investor, we revealed a gold stock coining it thanks to the latest gold boom. It shot up 28% over the past month, but we believe this is only the start.


Concerned about the yield curve? Find out what to do when recession hits…
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