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With the markets moving higher this month, concerns about the inverted yield curve have faded. Moreover, commonly cited fear indicators, such as the gold price, have declined in September. On the surface, this bodes well for traditional investments like blue-chip stocks and government bonds.

However, the recession fears are very much real. Although some analysts have adopted the contrarian bullish argument, I’m not entirely convinced. For example, CNBC contributor and Mad Money host Jim Cramer recently quoted legendary technical analyst Larry Williams. Cramer stated the following:

The charts, as interpreted by the legendary Larry Williams, suggest that it’s time to stop panicking, stop complaining and start buying. He thinks the cycle of fear and negativity has run its course. So if the averages haven’t bottomed already, they’re going to bottom very soon.

To be fair, Cramer made these remarks in late August. Thus, on a nominal basis, Cramer is right: stocks in September have moved much higher. But does that mean the concerns about the inverting yield curve are now gone? If you take the mainstream point of view, they are.

On the contrary, I believe the very fact that the yield curve inverted at all is a worrisome issue. After all, this dynamic makes no sense: investors are rewarded more for taking on less risk. If you want my opinion, we should button down while everybody else is apparently buying in.


What the Inverted Yield Curve Really Means

Normally, when people buy government bonds, they do so for security. Nowadays, the bond purchases represent an exercise in relativity. Let me explain.

Buying a longer-yielding bond (such as the 10-Year Treasury) assumes that interest rates will stay stable or move lower. Otherwise, if interest rates rise, the bond market will collapse. That’s because as interest rates rise, the bonds that yield a lower rate of return must be priced lower to make them attractive to buyers.

But with the inverted yield curve, it presents a strange dynamic. Again, buyers of shorter-yielding bonds assume that rates will either stabilize or decline. But with the longer-yielding bonds providing less returns than a shorter-yielding one, two things happen: one, more demand shifts into the shorter-yielding bonds, and two, demand is stronger for older longer-yielding bonds.

In other words, nobody wants the currently issued longer-yielding bonds (debt); instead, they want the shorter-term contracts or the old longer-term contracts. Thus, newly printed notes have no practical value unless they are offered at a discount to the face value.

That implies what we all know: the U.S. dollar is dying. With the yield curve debate, we’re really just arguing about when.

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