Yield Curve Inversion

[Helen]

Wildcat posted this in response to Donner's post about the possible Government manipulation of the stock market:

Really nothing I can do if the markets go to crap.

This has me wondering, if the yield curve inverts, will any of you take refuge in safer investments ?

-helen

[Nords]

Quote:

Originally Posted by Helen [i] This has me wondering, if the yield curve inverts, will any of you take refuge in safer investments ? -helen

"Safer"? No. But it might be worth the penalty to cash in the five-year CD for a higher rate on a shorter investment...

[Michael]

To me what is going on seems consistent with the normal procedure of getting the pain over early in the election cycle, so that the politicians can pump up the market in the 2 years leading up to the next Presidential election cycle (2007 and 2008).

[Gone4Good]

Personally, I’m not convinced that the investors driving up long-bond prices are any more intelligent or prescient than the folks driving up equity prices. That’s another way of saying I’m not convinced an inverted(ing) yield curve offers much predictive power.

I’ve also never had much luck in timing markets, and generally try to avoid the temptation to do it. In fact, I’d be a bit wealthier today if I stuck to that principal and resisted the urge to tinker around the edges of my portfolio. Recent examples of my market timing prowess include:

- I substantially reduced the duration of my fixed income investments because I was absolutely certain long-rates were going up. Still waiting on that one.

- I sold out of my high-yield bond position about a year ago because junk spreads were way too tight. I think average spreads have tightened by 100-150bp since I sold.

- I sold most of my REITs in June because they’re overvalued. They’ve continued to climb 4% over the past 5 months.

- I bought my NYC area condo in May of 1999 terribly worried that I was buying in at the peak of the market. My condo has doubled in value.

- Conversely a co-worker of mine sold his NYC apartment around the same time with the intention of buying back in when real estate prices fell – oops!

Almost everyone says it’s impossible to time the market. But I think very few people really truly believe that. We all think we’re smarter than the next guy and that we can deduce from an inverted yield curve, or some other supposedly predictive model, how to achieve above average returns. The truth for the vast majority of us is that it is simply not possible. My strategy (to the extent I can resist the temptation to do otherwise) is to maintain a balanced portfolio appropriate for my risk tolerance and let the markets do what they will.

[wildcat]

Helen -

Just my way of saying you should have a good allocation before & after the bad times in the market. If a person has that taken care of then there isn't much else to do. Doing nothing, aside from good allocation and rebalancing, is usually the best way to invest. Some do well by timing but the majority do not. If I try to time things it is with my "play" money. Sitting on 100% cash until the markets get cheap is just as risky as holding equities that appear (according to history) to be moderately overpriced IMHO.

[lazyday]

Quote:

Originally Posted by . . . Yrs to Go - I sold most of my REITs in June because they’re overvalued. They’ve continued to climb 4% over the past 5 months.

Yrs,

My experience has been that moves I've made based on my convictions on valuations, seldom pay off in the short term, but have helped my portfolio tremendously in the long term.

There were times when buying things like small cap value indexes seemed like throwing my money down the drain, sometimes for years at a time. I was convinced my investments were much cheaper than the market, but part of me expected that they would do poorly anyway, since they had been for so long and everyone else was so high on growth stocks. But I stuck with my value philosophy.

If 5 months ago I was truly convinced REITS were very overvalued, and I sold, I would try not to feel bad about it just because they've gone up more. Maybe in the long run, I'd be glad I sold.

(I don't have a strong opinion on REIT valuation today, but am underweight. I also don't like long bonds, though I don't pretend to know what they'll do in the future. I just think they are a poor risk. And I no longer think small or value indexes are relatively cheap. Large and growth indexes seem a little cheaper than market to me, but the numbers aren't extreme enough for me to be sure.)

I don't really advocate market timing, and think a Bernstein style slice and dice is probably best for most smart, disciplined people. But, your examples don't convince me that you're a bad market timer.

[Gone4Good]

Lazyday, I don't disagree with anything you said.

I'm still in the asset accumulation mode so I try to direct new investments into underperforming areas of the market. Similar to you I allocated more into small and mid-caps a few years ago and now more into large caps and even convertibles. Which is really just a function of rebalancing.

I typically don't sell out of asset classes so my sale of REITs and HY bonds were atypical moves. By "underweighting" these asset classes I'm taking a directional (speculative) bet on the market - one that has not yet worked to my advantage. However, my experience with long-bonds (and real estate) recently has reinforced my belief that you should maintain exposure to most areas of the market because you simply can't tell where performance will emerge. I was pretty convinced 5% in the 10-yr was the top-tick in the bond market. Now we're bouncing around 4%. No reason bonds can't go to 3%.

I would categorize your comments more along the lines of rebalancing, which I practice. But buying or selling asset classes (with the intention of overweighting / underweighting) based on some perception of value can't be anything other than timing. I think my Alpha in this regard is probably negative (although I did miss the tech bubble).

The point I was trying to make earlier was that in most instances I would have been better off not tinkering with my portfolio. I imagine most other investors are in that boat along with me.

[laurence]

eh, yrs to go, you sound pretty smart to me. Nobody got broke taking a profit, and you gotta sell sometime. Maybe you woulda hit red on the roulette table 1-3 more times, but why take the risk? Lot's of people here rebalance their portfolios, so we're all closet market timers. Congrats on buying the condo, I felt the same way buying my house in San Diego in 2001 for 274k. I was thinking, "who is going to pay this"

[Michael]

Quote:

Personally, I’m not convinced that the investors driving up long-bond prices are any more intelligent or prescient than the folks driving up equity prices. That’s another way of saying I’m not convinced an inverted(ing) yield curve offers much predictive power.

The predictive nature of the yield curve has nothing to do with the intelligence of bond traders. It is simply an acknowledgment that banks don't loan as much money to business when the yield curve inverts, which slows the economy. Banks don't make much money on these types of loans when the curve inverts.

[lazyday]

Quote:

Originally Posted by . . . Yrs to Go By "underweighting" these asset classes I'm taking a directional (speculative) bet on the market - one that has not yet worked to my advantage. However, my experience with long-bonds (and real estate) recently has reinforced my belief that you should maintain exposure to most areas of the market because you simply can't tell where performance will emerge. I was pretty convinced 5% in the 10-yr was the top-tick in the bond market. Now we're bouncing around 4%. No reason bonds can't go to 3%.

I don't try to make calls of where market tops or bottoms are, and I'm not sure anyone really can.
And I agree that bonds could go to 3%.
But if you really were convinced that long bonds were expensive at 5% and sold some there, I hope you don't give up now and rebuy at 4%. Unless perhaps you've made a permanent decision to never market time again....

Quote:

I would categorize your comments more along the lines of rebalancing, which I practice. But buying or selling asset classes (with the intention of overweighting / underweighting) based on some perception of value can't be anything other than timing. I think my Alpha in this regard is probably negative (although I did miss the tech bubble).

For others, I'd advise a fixed asset allocation, with rebalancing. To me, it isn't market timing if you really keep the same asset allocation over time. (But not all would agree)
For myself, I make big moves based on my perceptions of valuations, which I agree is a form of market timing.

Quote:

The point I was trying to make earlier was that in most instances I would have been better off not tinkering with my portfolio. I imagine most other investors are in that boat along with me.

Bernstien and others agree that most people, even most smart people, hurt themselves with their timing moves, buying high and selling low.
It seems to me like your moves were decent attempts to sell high, and in the long run I'd believe there's over a 50% chance those moves would pay off.

I guess if you believe your alpha is negative, you should stop market timing. IMO one should have strong convictions in one's investing style.

[uncledrz]

Helen
Inversion itself will only cause a higher percentage of fixed income to go shorter.

If it causes recession and then compression of p/e, would redirect percentage from fixed income to equities.

Real estate/hard assets would not be changed.

Uncledrz