Pay Attention: Recession Warning Signals Trouble Ahead

by Mike Larson
By Mike Larson

It all goes down in a few short hours. The second "hammer drop" from the Fed.

All signs point to Chairman Jay Powell and his band of monetary policymakers hiking rates by another 75 basis points.

That would be the second 0.75% increase in this cycle — an aggressive posture the likes of which we haven't seen in decades!

I told you last week about all the ripple effects these moves are having. And those effects are widespread, impacting markets, the U.S. dollar, stocks, bonds, real estate and more.

But what will it mean on Main Street? Simply put ...

Recession!

One of the most reliable indicators of a future economic downturn over the years is the yield curve. The curve is simply a representation of the yields on various U.S. Treasurys with different maturity dates.

In normal, expansionary times for the economy, shorter-term Treasurys have lower yields than longer-term ones. And that makes sense.

Why?

When you buy Treasurys, you're effectively lending money to the U.S. government. Your risk of loss from inflation or other future threats is greater when you lend for, say, 10 years rather than two years.

Banks use the same logic when lending customers money to buy a car or truck over a seven- or eight-year term rather than a three- or four-year term. They know the risk of default is higher the longer the loan will take to mature.

But when bond investors worry about a future recession, they start making trades that flatten the yield curve. They buy relatively more long-term bonds than short-term notes, which leads to long-term yields falling below short-term yields.

Take a look at the following graph, which I'll be discussing on July 28 at 11:30 a.m. at the 2022 Rule Symposium in Boca Raton, Florida. (You can still register to join me there by clicking here, by the way.)

 

It shows the difference between the yield on the two-year Treasury note and the yield on the 10-year Treasury note. This so-called 2–10 spread is one of the most common measures of the yield curve.

You can see that it's absolutely collapsed over the last 16 months, going from POSITIVE-159 bps last March to NEGATIVE-22 bps this month.

The curve is now more inverted than it's been at any time since just before the dot-com crash. And yes, that means this inversion is even worse than in the mid-2000s, just before the housing market crashed and took the stock market down with it.

This time around, we've already had one quarter (Q1 2022) of negative gross domestic product. The Q2 number hits the tape tomorrow, and there are strong indications it could be negative as well.

Economic purists will say two consecutive quarters of shrinking GDP don't mean we're in recession. But that's how many noneconomists define one.

Plus, that kind of nitpicking will be cold comfort to those on Main Street, who are starting to feel the sting of a slowing economy. Jobless claims just hit an eight-month high, for instance, while regional manufacturing indices are falling off a cliff.

What's more, the biggest retailer in the U.S., Walmart (WMT), just warned on earnings. The company said 2022 profit could plunge as much as 13% this year, compared with a previous forecast of around 1%. Walmart blamed strapped consumers, surging inflation and forced markdown activity for the miss.

What Can Investors Do About It?

As an investor, you simply have to pay attention to these developments. The combination of an aggressive Fed and a looming recession is toxic for many kinds of stocks, bonds and real estate.

It's why I've been warning about aggressive growth stocks for a year now. It's why I've been recommending you avoid high-risk bonds. It's why I've said the best move for potential house buyers is not to buy a house. And it's why I continue to favor Safe Money stocks and sectors over riskier ones.

There will come a time when the Fed is Wall Street's friend again. There will come a time when the economic outlook is stronger. But this is not that time. So, don't invest like it is!

Until next time,

Mike Larson

P.S. Dr. Martin Weiss and early stage investor Chris Graebe are going on the air to show how staggeringly profitable private market deals can be … and how to get first access to one private deal for Weiss members. If you'd like more information, check this out.

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