Don’t Panic: Here’s What the Yield Curve’s Warning Really Means

By John Jagerson and Wade Hansen

The indicator with the best long-term track record for predicting the top of the market is the interest-rate yield curve.

If interest rates on long-term debt are the same as (or less than) interest rates on short-term debt, it almost always indicates a major market crash is coming.

If you read this news this weekend, you couldn’t miss the endless headlines that the yield curve is flashing such a warning sign.

Before you get the wrong idea, keep in mind two things:

• Like our mid-sections during the holidays, the yield curve is not flat. Short-term interest rates are still below long-term rates. It has been getting a little flatter, but that is a common phenomenon, and it means there is no signal for a bear market – yet.
• Although a flat (or inverted) yield curve has the best track record for market crashes, it’s terrible at timing. On average, it takes 18 months from the time long-term interest rates dip below short-term rates before a bear market appears.

The last time the yield curve actually became inverted was August 2019. The S&P 500 rose another 20% after that before COVID-19 stomped on the market in February 2020.

Moreover, a flattening yield curve puts pressure on the Fed to stimulate the economy. Investors like it when the Fed is under pressure to stimulate the economy rather than fight inflation.

However, when the yield curve flattens, investors usually shift towards a preference in large-cap growth stocks rather than higher-risk small caps.

For example, large-cap tech [like Microsoft Corp. (MSFT), Apple Inc. (AAPL), and Broadcom Inc. (AVGO) ] helped the S&P 500 large-cap index close last Thursday and Friday in positive territory while the Russell 2000 small-cap index was negative. We expect that same pattern to repeat itself this week.

What Should You Do Now?

Focus on large-cap growth (tech and construction look great) and the big discount retailers; that will allow you to take advantage of falling long-term interest rates and the retail report from the U.S. Census Bureau on Wednesday morning.

We like…

• Target Corp. (TGT) looks good for new buyers. The Costco Wholesale Corp. (COST) report came out last Friday, and investors loved what management had to say; the company has been able to mitigate many supply chain issues and says issues in getting holiday items (toys) will stretch out the shopping season. Target has a strong positive correlation with Costco, and this makes TGT look very undervalued. We like any price under $240 per share.
• The last time we recommended Microsoft was near the bottom of its most recent drop, and we feel good recommending it again for entries. Less pressure on the Fed to raise interest rates means MSFT should break its prior high price this month. Any share price under $335 looks great for new entries.
• Masco Corp. (MAS) is another one we have recommended recently, and we stand by the stock. The company supplies fixtures and materials for construction companies and home improvement centers. If you have ever installed a Delta faucet or Behr lights, then you have done business with MAS. The company’s shares are still undervalued, and we like anything in the $68-72 range.

Sincerely,

John Jagerson & Wade Hansen
Editors, Trading Opportunities