Take Six - Random Investing Notes
A collection of insightful investment pieces to broaden knowledge and elevate the investing mindset. Includes: Yield Curve Inversion, Tech Bubbles, Gold vs. Treasuries, VIX
The Inverted Yield Curve
The inverted curve yield, specifically on the 3-month to 10-year yield, is a financial phenomenon where the yield (interest rate) on a 3-month Treasury bill exceeds the yield on a 10-year Treasury bond. This inversion is significant, as it has historically served as reliable indicator of an impending economic recession. It signifies that investors are concerned about the future are pursuing safer, long-term investments.
Here's a breakdown of why this happens and what it means:
Normal Yield Curve: Under normal circumstances longer-term bonds typically yield higher returns than shorter-term bonds, as investors require a premium committing their capital for an extended duration. This phenomenon to the formation of an upward-sloping yield curve.
Inverted Yield Curve: When the yield curve inverts, it indicates that short-term rates surpass long-term rates. This inversion implies that investors anticipate a slowdown or contraction in economic growth in future. Consequently, they seek the safety of-term bonds which drives down their yields.
Economic Implications: The 3-month/10-year inversion is particularly watched by economists and investors because it has preceded every U.S. recession since the 1950s.
Here’s another indicator that has proven worthy of predicting recessions…
Inverted Yield Curve
An inverted yield curve occurs when long-term interest rates are lower than short-term interest rates. The most popular comparison is between the ten-year and two-year bond yields. Positive values may imply future growth, negative values may imply economic downturns.
Tech Bubble
A tech bubble is a market phenomenon characterized by a rapid and unsustainable increase in the prices of technology-related assets, such as stocks of tech companies. This rise is often driven by irrational exuberance, excessive speculation, and a belief that the technology sector is immune to economic realities.
During a tech bubble, investors may buy stocks at overinflated prices, often ignoring traditional valuation metrics like price-to-earnings ratios. When the bubble bursts, stock prices plummet, leading to significant financial losses for investors.
A famous example is the dot-com bubble of the late 1990s, where internet-related companies saw their stock prices soar before crashing dramatically in the early 2000s.
The tech bubble burst in the 2000s and the decline was felt for almost two years. Guess what started rising? Precious metals and certain miners.
The accompanying chart from Bank of America illustrates how an equity bull market in energy, materials, and financials commenced concurrently with the 2000 tech and telecom collapse, based on sectors in the MSCI All-Country World Index.
History doesn’t repeat itself, but it often rhymes! Is artificial intelligence (AI) merely another piece in the line of the dominoes?
Gold vs. US Treasuries
At a high level, the relationship between gold and U.S. Treasuries is often characterized by their inverse correlation particularly with real interest rates. When real interest rates (nominal interest rates adjusted for inflation) are low or negative, as after 2000 tech bubble burst, the 2008 financial crisis, and COVID-19 pandemic in 2020, gold prices surged because the cost of holding gold decreased. Conversely, when real interest rates are high, such as during the mid-2010s the Federal Reserve began increasing rates, gold prices fall as investors prefer interest-bearing assets like Treasuries. This dynamic is rooted in gold's role as a hedge against inflation and economic uncertainty, making it attractive during periods of low real yields.
Observe how the accumulation of gold begins when the demand treasuries fall, and vice versa. It is all part of the cycle.
Furthermore, concerns about rising U.S. national debt and have significantly influenced recent times. As the national debt continues to grow, investors become increasingly worried about and economic stability, prompting them to turn towards gold.
Are we approaching another upward trend in gold reserves?
VIX
The VIX, or CBOE Volatility Index, is often referred to as the "Fear Gauge" or "Fear Index." It measures the market's expectation of volatility over the next 30 days, based on S&P 500 index options. Essentially, it provides a snapshot of investor sentiment and market risk.
When the VIX is elevated, it signifies that investors anticipate significant price fluctuations, often corresponding to periods of market stress or uncertainty. Conversely, a low VIX indicates a more stable market with lower expected volatility. Investors and traders utilize the VIX to gauge market sentiment, hedge against potential downturns, or speculate on future market movements.
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References
Crescat Capital. 2024. Crescat Firmwide Presentation. September. https://www.crescat.net/wp-content/uploads/Crescat-Firmwide-Presentation_September-2024_-8.pdf.