‘Snake Eyes’—Inflation and Inversion—Confound Markets

‘Snake Eyes’—Inflation and Inversion—Rattle Markets

April 8, 2022

Wall Street was a-twitter this week. But eccentric billionaire Elon Musk’s aggressive play for a stake in social media giant Twitter (a move that earned Musk a seat on their board) and the stock’s 27% one-day gain wasn’t the main topic of discussion. Instead, two big I’s drove the conversation: Inflation and inversion.

Early in the week, yields on government bonds briefly inverted—that is, the yields on some short-term bonds were higher than those on longer-term bonds. Such inversions are generally taken as a signal of a future recession as well as a sign that traders think Federal Reserve bankers may raise interest rates too much and too quickly, choking off economic growth.

Further deepening traders’ despair, often-dovish Fed Governor Lael Brainard said Tuesday that she believes the central bank needs to act quickly and aggressively to drive down inflation. Plus, minutes from the Fed’s latest meeting signaled a likely 0.5% interest-rate hike in May as the Fed’s next step.

Concern ebbed a bit when long-term interest rates rose midweek and the yield curve flipped back to normal. A bullish jobs report helped trigger the switch, with new unemployment claims falling to 166,000 this week, their lowest level since 1968. While good news for the U.S. economy, the tight job market may add wage inflation to already spiking price inflation, which gives the Fed an even freer hand to keep raising interest rates.

Inflation and inversion (and recession) are related: News of strong economic growth today can cause fears of inflation tomorrow…and worries over recession in the future. In our opinion, however, we’d need to see a much more persistent inversion of the yield curve before one can legitimately claim that the bond market is predicting recession.

All of this concern is based on conjecture anyway. Estimates for economic growth in the just-ended first quarter are quite low and the projections for the current quarter are rising. That flies in the face of calls for an imminent slowdown which is typically defined as two consecutive calendar quarters of economic shrinkage. The continuing worry though is that Federal Reserve policymakers will overplay their hand.

Housing as a Harbinger of Recession

To quote analyst and blogger Bill McBride, who was one of the first to predict the 2008 housing crash, “If the Fed tightening cycle will lead to a recession, we should see housing turn down first.”

McBride’s worry is that Fed rate hikes will lead to higher mortgage rates, cooling the housing market as a result. Indeed, the 30-year mortgage rate topped 5% this week for the first time since 2013, and home loan applications are down 40% from where they were a year ago.

Historically, a 5% rate is still low (mortgage rates sailed as high as 18% in the early 1980s). But less striking than the absolute number is the speed of the change: Borrowing costs have spiked 1.5% over the past three months—a 46.5% increase from where they were at the start of the year. That’s more than enough to make buyers wary.

Are we in line for the same sort of housing bust we experienced in 2008? That’s unlikely. Lending standards during the recent boom are much higher than they were in the mid-2000s. And with the job market booming, we shouldn’t see the epidemic of defaults and distressed sales that drove prices down in the late 2000s. But we may well see a decline in housing starts and new home sales.

If the housing market retrenches enough to spur a broad regional or even national price decline, especially if it occurs while the stock and bond markets are falling, that could well spark a recession. For now, it’s speculation rather than fact.

Chart of the Week: Does the Yield Curve Signal ‘Sell’ for Stocks?

Director of Research Jeff DeMaso:

While I’m in the camp that the yield curve is not yet inverted, for argument’s sake let’s say it is. Should investors take that as a reason to sell their stocks? In short, no!

Looking back at past yield-curve inversions, stocks have, on average, gained ground whether you are looking out over the next 12 months or until the onset of the next recession. In the chart below, you can see that, 12 months post inversion, stocks only declined in two of the six most recent occurrences dating back to 1978. And by the time the economy actually went into recession, the results look even better for those who stuck with their investments, with gains in five out of six periods.

Note: Chart shows returns for the Vanguard 500 Index fund for the periods specified. 1978 and 1980 dates are based on the 10-year to 2-year Treasury bond spread. 1989, 2000, 2006 and 2019 dates determined using the 10-year to 3-month Treasury bond spread. Sources: Morningstar, Adviser Investments.

Financial Planning Friday
3 Savvy Budgeting Strategies

Budgeting is something that many of us would rather avoid. But it’s an essential exercise—and often far easier than you think. In fact, investing time today will help you manage your money more efficiently and reach your goals faster in the future.

Let’s explore three common budgeting methods and how they might work for you. 

The 50/30/20 Plan. The beauty of this approach is that it’s so straightforward. Simply group your expenses into three types: Needs, wants and savings/debt. Specifically, earmark 50% of your income for necessary expenses (housing costs, utility bills, groceries, etc.). Then direct 30% toward discretionary items like entertainment or travel. Finally, dedicate the last 20% to savings and paying down debt.

This is an ideal method for beginners because it doesn’t require meticulous tracking of every dollar spent. The 50/30/20 proportions are guidelines that can shift a bit depending on your needs. But that’s also the strategy’s greatest weakness—the flexibility does less to instill discipline and create a routine compared to other approaches. To get started, we recommend automating the 20% (before paying expenses or spending on discretionary items) to make sure you meet your savings goals.

Zero-Based Budgeting. Often called the “give every dollar a job” approach, the goal here is to ensure that your income minus your expenses equals zero. You shouldn’t have a spare dollar at the end of the month—they’re all accounted for. In this case, savings and debt payments are considered expenses. It’s a smart approach that works best when your monthly income is consistent and you have a tight handle on your expenses. If you can stick to this method, you’ll know exactly how your money is being spent.

The Envelope Method. This classic strategy requires physical cash. (You know, those green pieces of paper we all used to carry around in our wallets?) To get started, make a list of your monthly expenses by category—groceries, dining out, utility bills, rent, etc. Remember to include infrequent outlays like gifts to friends and the occasional donation. From there, allocate one envelope per category and budget your cash accordingly. In this case, pulling cash from those envelopes is the only way you can spend. Of the three approaches, the envelope method requires the most discipline. When an envelope is empty, you can’t spend any more money in that particular category.

From a practical standpoint, this method is difficult to sustain over the long term, but it’s useful for someone with a tendency to overspend with credit cards who wants to course correct.

No matter which budgeting approach resonates with you, there is one common thread—financial awareness. It is impossible to create and maintain a budget without knowing your income and expenses.

Clients can try the “Spending” tool on the Adviser Insights portal (please contact your team if you need help getting on the portal). If you prefer pen and paper, click here for our Budget Worksheet. And click here for our podcast on the topic.

As always, if you have any questions about budgeting, please give us a ring. We’re here for you.

Podcast: Lessons From a Volatile First Quarter

In this episode of The Adviser You Can Talk To Podcast, Dan Wiener and Jim Lowell discuss what we’ve learned from one of the most volatile periods in recent market history and share their outlook for the rest of 2022. Topics include:

  • Can inflation be tamed?
  • Are bonds still a safe haven for investors?
  • What long-term impacts will the Ukraine war have on the global economy?
  • Is it time for U.S. investors to pull out of China?

Click here to listen now!

Ask Us a Question!

We’re always interested in the topics or concerns you might like us to comment on. As much as we try to cover the investment and economic fields every week, we know there’s still more that you might want to hear about. Ask us a question about investing, the markets or financial planning and one of Adviser Investments’ experts will answer it in a future edition of The Week in Review. CLICK HERE NOW TO POSE YOUR QUERY.

Adviser Investments in the Media

This week, Chief Investment Officer Jim Lowell spoke to Fox Business about how one can make gains in this volatile market.

In this week’s Market Takeaways, Senior Research Analyst Liz Laprade discussed Elon Musk’s Twitter play, while Portfolio Manager Steve Johnson offered his thoughts on why words matter when it’s the Fed talking.

Looking Ahead

Next week, inflation numbers will likely dominate the data, with updates on inflation expectations, producer prices and the consumer price index all due. We’ll also get fresh information on retail sales, imports, inventories, consumer sentiment and the federal deficit.

As always, please visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser Investments wish you a safe, sound and prosperous investment future.

About Adviser Investments

Adviser Investments is a full-service wealth management firm, offering investment managementfinancial and tax planningmanaged individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994, and have nearly 4,000 clients across the country and over $7 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. Our minimum account size is $350,000. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.


Please note: This update was prepared on Friday, April 8, 2022, prior to the market’s close.

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