Inventor of the yield curve indicator explains code red now flashing

The discussion below with Campbell Harvey is insightful. The ‘could this time be different’ questions are common, but in reality, GDP growth is routinely revised lower months and years after initial estimates, so the fact that recent quarters have reported still positive GDP growth to date, does not mean that a recession may not be already here or imminent.

The more useful take away for investors should be that equity returns after curve inversions tend to be “grim” as Harvey explains.  While value management rules have underperformed ‘growth’ during the recent momentum-driven ‘QE’ years, over the long run true value disciplines outperform because they tend to lose less than price-indicriminate ‘growth’ buyers once bear markets start.  During bear markets ‘growth’ investors typically give back years of previous gains in a matter of months, and then spend years thereafter trying to make back their losses.  This tends to be inefficient and traumatic in real life.

The bottom line is that whatever one’s chosen discipline, bear markets are part of each economic cycle and we are overdue for the next one.  If your plan is to ride it out and hope you recover in the long run, so be it.  But if your plan is to hope you will get away with staying long and not go through the give back cycle, you are woefully ill-prepared.

Campbell Harvey is a Professor at Duke University and a partner at Research Affiliates…Campbell cites the fact that 7 out of the last 7 recessions had been presaged by a yield curve inversion – which is what happens when it longer-term bond yields fall below shorter-term bond yields in the Treasury market. He believes that this phenomenon occurs when the market participants begin to grow more pessimistic about the economic outlook. The behavior of executives, lenders, borrowers and investors can change enough during these times to actually become a self-fulfilling prophecy – producing a negative feedback loop that drives a weakening economy into a full-blown recession.

Recessions are a normal part of the business cycle, although they can be painful to live and invest through.  Here is a direct video link.

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