The Reason Stocks Will Soar In The Next 20 Months
Stephen McBride | Aug 30, 2019 07:56AM ET
A reader asked me last week if it’s time to head for the exits.
There’s a lot of fear in the markets right now. Folks are nervous. Maybe you’re nervous.
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The past two weeks have been rough for the stock market. The S&P 500 recently suffered its worst day of the year. And stocks have now dipped 4% since hitting record highs in late July.
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If you watch any financial TV, you’ve surely heard this blamed on a troubling economic signal triggered last week called the “inverted yield curve.”
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I’ll tell you in a moment why it’s actually a good sign for stocks . But before that, let’s clarify what the inverted yield curve is… and why it matters to you.
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What the Heck Is an Inverted Yield Curve?
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If you’ve applied for a mortgage, you know the two most popular options are a 15-year mortgage or a 30-year mortgage.
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The interest rate you’ll pay on a 15-year mortgage is lower than what you’d pay on a 30-year one.
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Which makes sense, right?
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With the 30-year mortgage, you’re borrowing the bank’s money for twice as long. So you must pay a higher rate.
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It’s the same with the interest rates that the U.S. government pays on its bonds.
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99.9% of the time, the longer out a bond goes, the higher rate it pays. A 10-year bond almost always pays higher interest than a 2-year bond.
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But on Aug. 14, the interest rate on the 10-year U.S. bond sunk below the interest rate on a two-year bond.
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This “upside-down” situation is what investors call an inverted yield curve.
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A Reliable Sign That Something Is “Off” with the U.S. Economy
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It’s rare for the yield curve to invert. It’s only happened nine times in the last 50 years.
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It last happened in January 2006. Roughly two years later, we entered the 2008 financial crisis. U.S. stocks cratered 57% in ‘08–‘09.
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More bad news: Every time the yield curve has inverted in the last 50 years, a recession has eventually followed.
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Recessions are bad for stocks. Since the 1920s, U.S. stocks have sunk into a “bear market” 10 times. Eight of the 10 have come inside a recession.
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Also a Reliable Sign Stocks Will Go Up
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It’s important to know the yield curve inversion typically warns of a recession, years in advance. From the time the yield curve first inverts, a recession hits 20 months later, on average.
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Twenty months is a long time. And in those 20 months after the yield curve inverts, stocks usually perform well.
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The last time the yield curve inverted in 2006, the S&P crept up 22% before the onset of the financial crisis.
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The time before that, in 1998, stocks soared 55% before peaking. And the Nasdaq jumped a crazy 210% to form the infamous dot-com bubble.
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Not only is there a long lag between this signal flashing red and stocks topping out. You could say a yield curve inversion is a “buy” signal for stocks, at least in the short term.
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If the Economy Is in Bad Shape, Explain This to Me…
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Although the yield curve inversion is a reliable signal, it’s at odds with the “real” economy.
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Look at these stock charts of five “everyday” American companies.
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If the economy is on shaky ground, these companies should be struggling.
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After 20 straight quarters of rising sales, America’s largest retailer, Walmart Inc (NYSE:WMT), recently hit all-time highs.
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Fast-food giant McDonalds (SA:MCDC34) is looking better than ever.
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If we’re in an economic danger zone, why are tens of millions of folks paying $6 for luxury coffee at Starbucks (NASDAQ:SBUX)?
Credit card giant Visa (V) keeps zooming higher.
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And new highs in Home Depot Inc (NYSE:HD) suggest more Americans are renovating their homes than ever before.
If the economy is about to hit the rocks, why are these stocks hitting all-time highs?
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If a meltdown is coming, somebody forgot to tell the hundreds of millions of Americans who shop at these places.
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Here’s What I’m Doing with My Money Right Now
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Many investors assume they only have two choices now that the yield curve has inverted:
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1. Sell all their stocks and park the cash in their bank accounts…
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2. Or hang on and hope the next recession doesn’t wipe them out.
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This “all or nothing” mentality is a rookie mistake.
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There is a better way.
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Don’t panic. PREPARE.
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Prepare by committing to disciplined risk management with each stock you own. Any investor can do this by using “stops.”
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As you may know, a “stop” is a predetermined price at which you’ll sell a stock. Say you buy a stock at $100, and put a 20% stop on it. If the stock falls to $80, you sell immediately. No questions asked, and no second guessing the decision.
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Used correctly, stops keep any losses small while allowing your winners to ride.
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That way, if US markets continue to perform well, your nest egg will keep growing.
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And if markets turn down tomorrow, your stops act like a “circuit breaker” for your portfolio.
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They’ll get you out before a stock loses too much ground.
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Let Me Be Clear
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The yield curve inversion is a “red flag” to take seriously.
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It’s one of the most reliable indicators of a recession there is. It’s definitely not a good thing.
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It would be irresponsible to ignore it.
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But as I said, 20 months is a long time. The average person has about 35 working years, or 420 months, to build wealth through investing.
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Twenty months represent around 5% of your investing life.
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Are you willing to squander 5% of your investing life?
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To park your money on the sidelines until a potential recession comes and goes?
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With scary headlines swirling, that might “feel” like the safe, prudent thing to do.
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But the data are clear. For the next twenty months or so, we’re in an environment where it has historically been good or great to own stocks, especially disruptor stocks .
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Think carefully before you waste it.
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