| Probably every investor's biggest wish is to be able | | | | underlying companies will report in the next six to |
| to predict the direction of the market. However, the | | | | nine months. This allows them to enter some |
| market is so forward looking that profitability does | | | | positions, close out others or ignore certain |
| not exactly like in predicting market returns but often | | | | companies. |
| in predicting the economy itself. Imagine, for | | | | It should be noted that while three percent is the |
| example, being able to forecast economic recovery | | | | magic number, it is not an inflexible value. Studying |
| and recessionary periods before regular investor's | | | | the monthly trends of the yield curve provide a |
| could. This could mean less loss (or even profitability) | | | | better understanding as to where the rates are |
| during market downturns by getting out or going | | | | headed or, better yet, where they have come from. |
| short while others are still invested "long" and vice | | | | This gives such an investor something of a head |
| versa. In fact, with the S&P 500 returning | | | | start over other investors who are relying purely on |
| 64.8% from March 9, 2009 until December 31, 2009 | | | | opinions from the folks at CNBC or the newspapers. |
| (or 19.7% for the entire year), knowing what the | | | | Inverted Curve |
| market forecasts for the economy certainly makes | | | | An inverted curve happens when short-term rates |
| the task of investment management much less | | | | are higher than long-term rates. Of course, this does |
| complicated. | | | | not always happen like this, but when rates on short |
| One of the often overlooked tools when it comes to | | | | term investments are very close to those offered |
| economic forecasting insofar as investing is | | | | on long-term investments, investors need to be |
| concerned is the Yield Curve. Let's take a look at | | | | extremely cautious if investing in equities. |
| what the yield curve signals about the market and | | | | The reason for the rates being so close is that bond |
| tells us about the overall economic forecast: | | | | investors would rather take a lower long-term rate |
| Steep Curve | | | | because they expect the short term rates to fall |
| Normally, there is a three percentage point difference | | | | through the floor. This happens whenever the |
| in yield between 3 month Treasury bills and 30 year | | | | economy is expected to take a pause, definitely bad |
| Treasury Bonds. When that difference is more than | | | | news for equity investors. |
| three percentage points, the indicator from the | | | | Summary |
| market is that the economy is expected to enter an | | | | While these two signals are clearly not exhaustive, |
| expansion phase. This is signal normally predicts an | | | | they do allow investors to find the turning points in |
| end to a recession and provides bond and stock | | | | the economy and determine whether market |
| market investors with cues that they will see | | | | strength is sound or simply superficial. It can also help |
| strength in the near future. | | | | when deciding whether to make changes to current |
| Equity investors will study yield curves because they | | | | long-term security holdings. |
| can have a better understanding about what the | | | | |