When we think of 2008, plummeting stock prices and foreclosed homes come to mind. The 2008 financial crisis, which led to the Great Recession, was caused by the overabundance of the borrowing and lending of housing debt (specifically subprime mortgages). These events made an enormous impact on how we think about risk and the danger of blind speculation. Hindsight is 20/20, however, amongst the speculation were indicators that told wise investors that they should bet against commercial banks and even the entire United States’ economy. Important economic indicators, such as interest rate movements and public policy, showed cracks in the economy then, which makes it an important concept to understand and apply to today’s economy.
When investors talk about interest rates, they most often are referring to the Federal Funds rate. The Federal Reserve Bank (The Fed) sets The Federal Funds rate, the rate at which banks lend deposits to other banks overnight. In 2003, rates were lowered to 1%, but since the economy was surging, the Fed began raising rates by 0.5% every three months from June 2004 until June 2006, stopping when rates reached 5.25%. Raising rates is theoretically supposed to fight inflation, so the Fed strongly believed that the measures they took were required to cool off an overheated economy.
You may recognize the saying “when interest rates go up, bond prices go down.” We paid close attention to the interest rates on Treasury bonds, debt issued by the United States government, and found that the interest rates on six-month Treasury bills moved up higher in tandem with the Federal Funds rate. Investors in 30-year US Treasury bonds saw the prices of their bonds increase as other investors piled into longer-term bonds to protect themselves from rising rates. 2006 marked the year where the interest rate on the six-month US Treasury bill was officially higher than the interest rate on the 30-year bond. The six-month bill was around 4.7%, while the 30-year was at 4.55%. More time invested in a bond should equal more reward since you are taking on more risk. However, if people view interest rates six months from now as less certain than the interest rates 30-years from now, this reverses the traditional risk-return tradeoff. When a longer-term bond gives investors a lower rate than a shorter-term bond, this is called an inverted yield curve. It is a good indicator that markets will plunge as inverted yield curves have historically occurred right before recessions.
The inverted yield curve indicator signals to investors that it may be time to exit the market. With greater uncertainty surrounding how quickly the Federal Reserve will raise rates in today’s market, we could all take a lesson from the past. Fogel Capital Management, Inc. has over 20 years of managing clients’ portfolios, including through the Financial Crisis of 2008 and recessionary periods. We put time and care into our economic analysis to mitigate market events like these. For a free portfolio consultation, please call us at 722-223-9686.