Investors have sold stocks on nervousness surrounding the inverted yield curve. No inversion this large has occurred since 2007, right before the 2008 financial crisis. But don’t indiscriminately slam that “SELL” button just yet. Yield-curve inversions merely indicate recessions rather than predict them.
However, given the length of the economic cycle, cautious investors could take the recent yield-curve inversion as a signal to go into cash or low-cost stocks.
What Is an Inverted Yield Curve?
In most cases, longer maturity dates on bonds tend to bring higher interest rates. However, anomalies sometimes occur. One example involves an inverted yield curve. The yield curve inverts when the interest rate on 10-year treasury bonds dips below the same interest rate on three-month bonds.
With the trade war in Asia looming, investors have sold stocks and put money into the 10-year treasury as a haven. As a result of increased demand, the interests rates on these bonds have fallen and the U.S. now faces the most significant inversion since 2007. As of this writing, the three-month Treasury yields 2.36%. Meanwhile, the 10-year interest rate has fallen to just above 2.23%. Hence the yield curve has now inverted by almost 13 basis points.
This worries investors mainly because of the length of the current economic cycle. The current recovery first began in March 2009, making this the eleventh year of the ongoing expansion. Since 1945, economic expansion cycles have lasted for an average of 58.4 months. Hence, the current cycle has now run more than double the length of the average period.
That said, investors should see the length of the expansion as a risk factor instead of a sign of a looming recession. Australia has seen 27 straight years of economic expansion. For this reason, we cannot assume the U.S. current growth period will end soon.
Investors Can Still Find Stocks to Buy
Moreover, even if a recession occurs, investors can still find stocks to buy. This typically happens because some companies operate on different economic cycles. For example, AbbVie (NYSE:ABBV) has faced a looming patent expiration on Humira, a key source of revenue. Consequently, ABBV stock trades at a forward P/E ratio of just 8.25. Moreover, ABBV’s dividend yield stands at about 5.4%. What makes the cash return more significant is the fact that AbbVie has built a 46-year track record of annual payout hikes that will likely continue. Even with a recession looming, I cannot recommend selling such a stock in that instance.
The same holds true for AT&T (NYSE:T). T stock has suffered as competition in wireless as well as cord cutting hurt profits. Moreover, it had to spend tens of billions of dollars to build a 5G network to remain competitive. However, thanks to 5G, AT&T looks poised to begin an expansion cycle. With or without a recession, customers will make this switch, and this should bolster AT&T stock. Further, the forward P/E stands at 8.8 on a stock with a 34-year history of dividend hikes. Hence, the payout should continue to increase annually despite a 6.6% dividend yield.
Concluding Thoughts on the Inverted Yield Curve
The inverted yield curve may or may not signal a coming recession. However, cash and low-cost stocks will serve investors no matter what happens to the economy. The recent yield curve inversion is the most significant since 2007. As a result, stocks sold off as investors feared another economic slowdown. The current economic expansion also causes concern as it has now persisted more than twice as long as the average post-World War II expansion.
Still, investors should not panic. For one, Australia has shown that expansion cycles can persist for decades. Further, many stocks have seen recessions of their own in recent years. Consequently, investors can find equities at low P/E ratios, some of which offer growing dividends with high yields.
Investors cannot avoid a recession. However, by remaining nimble and finding stocks coming out of a downturn of their own, investors can still profit.
As of this writing, Will Healy is long ABBV stock. You can follow Will on Twitter at @HealyWriting.