Financial and market manipulation occurs in many forms, be it a central bank guiding market prices, as has been the case in the precious metals markets over the last few years, by traders utilizing technological advancements such as high-frequency trading, or entities triggering sell/buy orders by taking significant short/long positions. This week, MarketWatch.com released an article detailing revelations by the chief market strategist for LPL Financial, Jeffrey Kleintop, regarding interest rates and their ability to indicate recessions. The article raised an interesting thought; are economic indicators valid in a manipulated economy? Our belief is that investors must look past the data at face value.
Kleintop discusses the yield curve in his piece and its historical relevance in foreshadowing recessions. A normal yield curve shows that the longer the duration of a debt instrument, the greater the yield. An inverted yield curve is when short term debt instruments have a higher yield than longer duration debt. For example, 10 year treasuries are paying 2.6% right now. If 3 month T-bills were paying more than 2.6%, that would signal an inverted yield curve.
It is no secret that the Federal Reserve has been keeping interest rates artificially low for an unreasonable amount of time in an effort to jump start the economy. These artificially low rates have failed to have any significant economic impact (as proven by lackluster GDP numbers), have decimated the earning potential of retirees that rely on interest bearing instruments for income, and have altered the yield curve. What would happen if short duration yields did in fact rise above long duration yields?
Some economists argue that an inverted yield curve in today’s market bears no meaning, as the laws of supply and demand will prevail and that foreign demand for our debt will result in declining long duration yields, opposed to signifying a coming recession. However, Kleintop does have some historical precedence backing his case that an inversion could lead to a recession.
In his piece, Kleintop points out that since 1967 the yield curve has started to invert on 7 different occasions, and each time the economy went into a recession 18 months or less from when the inversion began. We have made our case that we are likely much closer to a recession now than one would believe, based off of high unemployment numbers, soft retail sales and overall economic sluggishness as evidenced by the most recent GDP report. While equities continue to historic highs, the earnings have little to do with overall economic trends and more to do with easy money policies from the Federal Reserve driving the markets higher.
As money managers we rely on economic data to forecast the markets; however that job is made significantly more difficult when we learn that data is often misrepresented. As markets and data continue to be manipulated, assessing traditional indicators has proven unreliable. While economic reports are a good basis, anecdotal evidence will always be the trump card when evaluating the economy. As the saying goes, “It’s not what you know, it’s what you think you know that isn’t so.”