Week in Review: Overseas News and Yield Curve Creates Selling Pressure

David Peltier, Senior Investment Analyst
Updated: December 8, 2018

It was a short, but volatile week for U.S. markets, which were closed on Wednesday, in remembrance of President George H.W. Bush.

The big story this week was the partial inversion of the U.S. Treasury yield curve, as stocks swung violently against each conflicting headline resulting from ongoing trade talks with China and potential OPEC production cuts.

The yield curve is an important barometer for stock investors of all shapes and sizes. In general, the curve slopes upward over time, as positive economic growth and inflation tend to go hand-in-hand.

Source: www.treasury.gov

However, the curve inverted this week, when 5-year interest rates moved below 2-year rates. The real canary in the coal mine for economic watchers is the 2-year interest rate versus the 10-year rate, which has inverted prior to every U.S. recession over the past 50 years.

While this warning sign has created a false alarm or two over the decades, it’s no surprise that some folks are concerned the 2-year and 10-year notes are within 10 basis points of each other, which is the flattest since 2007.

You Can Still Make Money After Inversion

A recession does not necessarily spell doom for all investors. According to a study published by Jefferies this week, stocks traded higher between the yield curve inversion and actual sign of U.S. recession (an average of 21 months later) each of the past five instances.

For one thing, slower economic growth favors taking a more defensive stance, which should benefit dividend stocks. To this point, Tuesday was the single best trading session for defensive stocks versus cyclical names in more than two years.

Taking Cues from Overseas

The volatility in the first half of the week was driven by ongoing trade talks with China, while the OPEC meeting in Austria sparked trading activity in the latter half.

Looking ahead to next week, we may be taking our cues again from overseas, as the final Brexit vote will be cast in U.K. Parliament on Dec. 11. This year has been marked by the return of trading volatility and the headlines out of London next week will likely create some more white-knuckle moves.

Protecting Capital and Generating Income Despite Volatility

Tuesday marked the fifth 3% daily decline in the U.S. for 2018, which is the highest number of such occurrences in seven years. The average investor shies away from volatility, even though it often provides us the opportunity to be contrarian.

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