Watch out! It is often said that when the long-term Treasury yield dips below the yield on short-term Treasuries, then an economic downturn might not be too far away. It could take as long a year for recession to happen. But forewarned is forearmed.
Point is, it is reasonable that the yield on long-term Treasuries should be higher than short-term borrowing rates. After all, if we are lending money for a longer term, even if it is to the US government, then we want to be adequately compensated for taking on the extra risk. Anything could happen within 10 years, especially when the people in charge are not very smart.
So, when the difference between the interest rate on long-term and short-term loans starts to narrow, then it could mean that investors are getting worried. I am surprised that it has taken them this long to recognise the incompetence of the US administration.
Thanks to America’s flaky policies, inflation is stubbornly high not only in the US but elsewhere, too. The European Central Bank has warned that inflation could remain elevated for longer. ECB president Christine Lagarde has described its latest interest-rate hike as a no-brainier. Could that be a dig at America?
It is still a coin-toss as to whether the Fed will succumb to the pressures from bond investors and raise the Fed fund rate further. But long-term investors should be more focussed on company fundamentals than on anything that the US central bank might do.
If the ECB is right in its assessment that inflation might not return to its 2% target until late 2027, then stock markets everywhere could be in for a rough ride. But bear in mind that inflation takes no prisoners. It will erode the purchasing power of our money unless the cash is properly invested.
But as far as recession is concerned, it is a normal manifestation of business cycles. Most companies know how to deal with recession. They cut costs. But inflation could add a layer of complication to the mix. Inflation coupled with recession is not a pretty sight.
It would be natural for investors to cut and run. There are already signs that some investors could be baling on equities. But that could be a mistake. Economic downturns are often some of the best times to buy shares at discounted prices.
As an income investor, I am continually scouring the market for dividends. When share prices are high, those sources of income can be harder to find. But as interest rates start to climb and economic activity start to slow, it can make my job a whole lot easier.
I am looking for companies that make things that consumers can easily afford and things that they can’t easily do without. It can be a good place to start looking for companies that have pricing power, high returns on equity and are capable of generating free cash flow.
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Disclosure: David Kuo does not own any of the shares mentioned.
