Skilled investors create portfolios that perform well under normal conditions and remain resilient in downturns

The risk management approach

Recent fears spread by the media regarding the yield curve inversion, particularly the 10-year minus 2-year Treasury yield, have been framed as a signal of an impending US recession. The media often claims that when this curve inverts and then dis-inverts, a recession follows. However, the original concept of yield curve inversion, developed by Harvey Campbell, does not rely on the 10-year minus 2-year yield curve but rather the 10-year minus 3-month yield curve.

Currently, this curve remains inverted and has not yet dis-inverted. While the curve may eventually dis-invert, this doesn't necessarily guarantee a recession, as the outcome remains uncertain. But why does this curve hold so much influence over economic predictions? What is the outlook for the U.S. economy? Should investors attempt to time the market, and how should they respond to this data? Let me explain further

In past yield curve inversions, the inversion occurred because the 10-year yield dropped, singling fear of an economic downturn. Investors shifted to safer long-term bonds, driving prices up and yields down. This time, however, the 10-year yield went up, but the 3-month yield rose even faster, due to aggressive interest rate hikes by the Federal Reserve aimed at controlling inflation. The 3-month yield jumped higher than the 10-year yield, causing the inversion, but this wasn’t driven by investor fear of a recession as it typically is. Instead, it was caused by policy actions from the Fed. So investors shouldn't blindly assume it based on this inversion alone, as its cause differs from past cases.

The curve may eventually dis-invert, and while a recession could follow, the timing is uncertain. It can take anywhere from a few months to a year for a recession to occur after dis-inversion. Currently, the economy remains strong, and the likelihood of an imminent recession is low. However, there's a strong chance that the stock market will continue to reach record highs this year. As an investor, it’s crucial to understand your odds of winning versus losing so you can effectively switch between defensive and offensive strategies in risk management approach. I’ll explain more.

The outlook for the U.S. stock market appears bullish due to several key factors:

Historically, when the market rises by 10% or more in the first half of the year, there's a good chance that the second half will also see continued gains. This historical pattern suggests that if the momentum continues, investors could see additional returns in the latter half of the year.

The expectation that the Federal Reserve will cut interest rates significantly supports the bullish outlook. Lower interest rates tend to stimulate economic activity by making borrowing cheaper for businesses and consumers. This, in turn, can lead to higher corporate earnings and increased stock prices. While there’s debate over the magnitude of the cuts, the general consensus is that they are coming, which is seen as positive for the market.

Additionally, labor market conditions are gradually softening, which might reduce inflationary pressures, making it easier for the Fed to cut rates without destabilizing the economy. As long as employment remains relatively stable, consumer spending, which drives a significant portion of U.S. GDP, should remain strong, thus reducing the risk of a recession. 

It's fine to have opinions, but they shouldn't be the sole basis for investment decisions