There is a pretty good correlation between a flat or inverted yield curve and the occurance of a recession within 1-2 years. Well, we are there – the inverted yield curve, that is.

This excerpt from an FDIC economist’s explanation of what the yield curve does (and doesn’t) tell us is pretty clear. The chart needs some explanation, IMHO…

The line goes up as the difference between the 10-year and the current Fed rate (yield curve) increases but this isn’t the important part. As the rates converge, the line goes down, indicating a situation that may become problematic. If the current rate becomes larger than the 10-year rate, the difference is negative and the yield curve is said to be inverted. This is especially bad.

On the chart, there are horizontal rules. The table on the right shows the historical probability of a recession when the yield curve has been in that range. Generally, when the difference is substantial and positive, the likelyhood of a recession is low as indicated by the percentages in the table. The line goes up during recessions as the rates diverge and return to “normal”. When the difference is low or even negative, the likelyhood of a recession is high.

The blue vertical bars indicate the years of actual recession. Notice that they are usually 2-3 years wide and follow a low point, sometimes immediately, sometimes with a lag of a couple of years. The legend is misleading – the recession isn’t the period between the vertical bars, it is the width of the vertical bar.

There have been lots of recessions following the inversion of the yield curve. Can the next recession be far behind?

Some Comments on Learning that remind us that the current education system is, at best, misguided. There are plenty of examples of playing and informal learning that are really exciting for the learner and for the observer. There is hope…

One thing about the school of experience is that it will repeat the lesson if you flunk the first time. Author Unknown

Several smart affluent lady friends say they need help to manage their money – they don’t have time, they don’t have the knowledge (even the one with the MBA) and/or they “trust” their financial advisor. I understand the lack of self confidence for taking full responsibility for your financial affairs, but it just isn’t that difficult or time consuming to do a reasonably good job on your own. Look at all the guys who do this for a living – not a rocket scientist in the bunch.

There are lots of really smart folks out there who share their ideas and strategies. Michael O’Higgins’s investing rules are well publicized. He doesn’t require you to give him all your money to hear the “secret” formula. Timewise – this strategy takes about an hour once a year or so.

1. Get paid for taking risk. – Throughout most of financial history, investors have been paid handsomely for taking the risk of owning stocks. If the earnings yield, also known as the earnings/price ratio, is below the yield on AAA Corporate bonds, avoid stocks and put your money into long term 0% coupon U.S. T-Bonds.
2. If the price of gold is rising, don’t buy bonds. – The price of gold has correctly predicted the course of long term U.S. interest rates in 26 of the last 32 years. If gold’s price has risen over the past year, avoid bonds.
3. When buying stocks, stick to the “Dogs of the Dow”. – The 10 highest dividend paying DJIA components have consistently beaten the Dow by wide margins with below average risk.

What is a body to do? Stop spending money on designer drinks at Starbucks for a start. The one near us has longer lines than I can ever remember. All these folks willing to plunk down an hour’s worth of work for a coffee and a pastry mid morning and a blended drink in the afternoon. Amazing!

Even scarier – the moms driving up in their urban assault vehicles to buy coffee drinks and pastries for their little kids. What ever happened to milk and cookies? Or apples?