Track yield curve, not the president
Ratio between long-term, short-term interest rates can signal recession
A long line of U.S. presidents has failed to act as expected, and Donald Trump likely will be no exception, a Fox Point economist says.
Automakers and others interpreted an April 1962 speech by thenPresident John F. Kennedy to mean he was suggesting U.S. Steel roll back a recent price increase because of potential inflationary threats. The stock market declined amid worries the federal government was unfriendly to business, but JFK later announced probusiness tax cuts.
Richard Nixon in 1971 took the unusual step for a Republican of imposing wage and price controls aimed at stanching inflation. Ronald Reagan, also a Republican, took an antitrade stance when he imposed extreme tariff and import limits, although his motivation was likely to gain a better bargaining position in trade talks, says Clare Zempel, principal at Zempel Strategic in Fox Point.
Meanwhile, Bill Clinton, a Democrat, was an unwavering supporter of the North Atlantic Free Trade Agreement, which eliminated many trade barriers between the United States, Canada and Mexico and was disliked by U.S. labor groups that constituted a large portion of Clinton’s political support.
So when it comes to Donald Trump, Zempel says it’s a waste of time and energy to try to figure out what he might do from a policy standpoint.
“Presidents often do things that are different from what you expect,” he said.
Zempel says investors are better off tracking a more reliable measure: the yield curve.
The yield curve tracks the difference between long-term and short-term interest rates. All recessions since World War II have been preceded by an inverted yield curve, where long-term fixedincome securities have lower yields than their shorter-term counterparts, Zempel said.
Currently, long-term yields are higher than short-term yields, he said. So the question is: When might that ratio flip and signal that a recession is looming?
“For the next several years, there doesn’t seem to be a material risk of recession worth worrying about,” Zempel said. There shouldn’t be a yield curve inversion until at least 2018, which would put the next recession at 2020, he said.
With the Dow Jones industrial average pushing 20,000, some worry the stock market is overvalued. But Zempel said relative to where interest rates are, and where they are likely to be in the next 12 to 24 months, the stock market is nowhere near extremely overvalued, nor is it vulnerable to a major decline.
He says the stock market is likely to continue rising until the yield spread inverts.
“If the market jumped 15% we could be at the point where it was exhibiting irrational exuberance, but until and unless we get that, the market is more likely to continue rising than falling,” he said.
In the current environment, Zempel says he strongly favors stocks over bonds, and small company stocks over large company stocks.
iShares Russell 2000 (IWM) tracks the investment results of the Russell 2000 Index, which measures the performance of the small-capitalization sector of the U.S. equity market. The shares have a 52-week range of $93.64 to $138.82.
The effects of likely federal deregulation should benefit small companies, Zempel said.
PowerShares DB Commodity Tracking ETF (DBC) tracks changes in the level of the DBIQ Optimum Yield Diversified ABOUT THIS
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Commodity Index Excess Return. Among the commodities in the index are crude oil, heating oil, natural gas, gold, silver, corn, wheat and others. These shares have a 52-week range of $11.70 to $15.98.
“Commodities have already moved but the improving world economic outlook should continue to support further advances,” Zempel said.
The biggest risks here are the possibility of a threat to civil liberties that would undermine the economy, or a market correction driven by an unforeseen event like war or a natural disaster, he said. Both funds have potential to beat the overall market over the next 12 months, Zempel said.