Some market participants have expressed concern about the flattening yield curve. They have noticed the flattening occurring in the U.S. Treasury yield curve and have proclaimed that a recession is on the way. This has sparked a very interesting debate surrounding the causes of the flattening curve – is it due to the actions of the Federal Reserve and global central banks or is it the result of supply/demand dynamics in the marketplace? The correct answer will highly influence how the flat curve signal should be interpreted; will history have precedent or is it different this time (cringing as we write that statement)? For RIAs and other institutional investors, this debate has serious implications for your bond portfolio as well as your overall asset allocation. While we have our opinions on the matter (see below), we want to provide you with another signal to watch – financials. More specifically, watch the equities of the money center banks. If they fall -20% or so, we most likely have our answer to the debate above.
While many investors fret about the flattening of the yield curve over the past six months, it is not a huge concern of ours at this time. Our reasoning is, in part, due to observations in the financial sector. In the past, the occurrence of a flat-to-inverted yield curve has foreshadowed a recession which would exert pressure on the financial sector. Currently, however, we are not seeing that pressure. The credit qualities of names such as Citigroup, JPMorgan, Morgan Stanley and American Express are at the highest levels in the past seven years. Financial equities also continue to perform well with many reaching new highs. This has led us to believe that this year’s flattening is being driven by technicals such as central bank bond purchases and pension fund liability matching, more than a sign of pending recession.
Given the current favorable economic environment, financials should continue to benefit as business activity expands and interest rates rise. With that said, we will be closely monitoring credit and performance metrics in the financial sector and would adjust our opinion if the equities of money center banks were to sell off by -20% or so. This would lead us to expect a weaker credit environment ahead and potentially, a coming recession.
This commentary is provided by Bramshill Investments, LLC for informational purposes only and may contain information that is not suitable for all investors. Certain views and opinions expressed herein are forward-looking and may not come to pass. Investing involves risk, including the potential loss of principal. Past performance may not be indicative of future results, which are subject to various market and economic factors. No statement is to be construed as an offer to sell or a solicitation of an offer to buy securities, or the rendering of personalized investment advice.