Are you ahead of the curve?
Our take on recent talk of an approaching recession.
2 min read
Fears of a US recession returned last week when yields on short-term bonds rose above those on longer-dated bonds – referred to as an ‘inverted yield curve’. But investing in markets is not the same as investing in the economy and sensible navigation should determine future returns.
Last week’s yield curve news sounded a siren that a US recession might be on the way – it’s generally considered a chief warning sign. If a downturn does materialise, however, it could be some time before it actually happens.
History shows that when a yield curve inverts it can precede a recession by 12-18 months – although there have been occasions when it’s happened sooner, taken longer, or not happened at all.
The big thing markets don’t like – perhaps even more than a recession – is a surprise. And this was no surprise. Markets knew it was coming and have been preparing for slower growth for some time.
Coutts also predicted a slower growth environment and our portfolios and funds have been well-positioned as a result. We’ve exited investments in riskier markets in favour of more defensive areas and raised our positions in government bonds, for example.
Lilian Chovin, investment strategist at Coutts, says: “Recessions sound like bad news and they can bring difficulties for individuals and companies as economic conditions tighten. But investors should keep in mind that we invest in markets, not economies. Economics can affect markets of course, but it takes time – and that means investors can mitigate much of the risk.
“The last recession we had, in 2008, was exceptionally severe and bad for investments. But the numbers show that markets, and a well-balanced portfolio, can still rise during a typical recession and even in the run-up to it.”
Stay invested, stay dynamic
Lilian stresses that “nobody knows exactly when the next recession will happen and nobody knows what markets will do when it does arrive”.
“Your best move as an investor is to stay invested and have a dynamic asset allocation within your portfolio or fund – tilted towards riskier assets in good times and safer assets in more challenging times,” he says. “That reduces the risk of large drawdowns.”
Always remember though, that past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in.
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Markets had already started to price in the news of a slowing US economy in 2018, which affected performance, but they have since rebounded. This was driven by a couple of factors.
As ever the pessimism was overdone and markets bounced back as investors looked again at the risks and found the appropriate positioning.
Also, central banks saw the risk of recession and reeled in their plans for economic tightening. This has the potential to soften the impact of a downturn on markets by ensuring the money supply stays supportive.
What is the yield curve?
In normal circumstances, investors buying bonds – who are effectively issuing loans – would expect to be compensated more for lending money over the long term than the short term. So the yield curve usually reflects lower interest rates for short-term bonds and higher rates for those where the payback period is longer.
When the opposite happens, and long-term interest rates become lower than short-term ones, we have an inverted yield curve.
Long-term interest rates on bonds are driven by market expectations of growth and increasing inflation. If they drop so much that they fall below the rates for short-term bonds, it shows widespread expectation that the economy is going to weaken over time. That’s why it’s seen as a sign of an approaching recession.
Keeping a close eye on developments
Lilian says Coutts continues to monitor economic and market data to inform its investment decisions.
“Difficult economic times are a fact of life,” he says. “We can’t avoid them, but the preparations we make can reduce the effect they have on a diversified portfolio or fund. And times of volatility and inflexions in the cycle also bring potential opportunities that smart investors can use to their advantage.”
When investing, past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.
About Coutts Investments
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