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A guaranteed recession

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By Michael O’Connor

The bond market has shot back into focus in recent weeks.

For the last 40 years, it has been home to one of the most impressive bull runs in history.

The disinflationary period from the early 1980s saw the structural decline of interest rates. Bizarrely, US Treasury Bonds were offering 16% a year back in 1980, a far cry from the pennies on offer today.

Over the intervening years, continuous interest rate cuts were needed to facilitate GDP growth, but as rates approached zero, the central banks' weapon of choice ran out of ammo. Interest rates are now rising again as inflation persists.

The 10-year treasury has gone from a low of 0.5% in the summer of 2020 to 2.4% as of the end of March.

As the four-decade bull run comes to an end, what's next?

Is the negative correlation between equities and bonds, the cornerstone of a diversified portfolio, now officially dead?

Is a recession imminent?

Recession Rumours

If historical indicators are to be believed, then a recession is on the horizon. At the end of Q1, we saw multiple yield curve inversion, reigniting debates about an imminent recession.

Yield curve inversions between 2- and 10-year bonds have long been regarded as a solid indicator of a recession in the next 12 to 24 months.

In simple terms, a yield curve inversion occurs when the interest rate paid on short-term debt is higher than the interest rate paid on long-term debt of the same quality.

In a healthy economy, the yield curve should be upward sloping (longer-term rates higher than short-term rates). Logically this makes sense as investors seek higher returns as a reward for the greater uncertainty that comes with investing over longer periods.

When short-term interest rates exceed long-term rates, market sentiment suggests that the long-term outlook is poor, and the yields offered by long-term fixed income will continue to fall.

But like everything, it's not quite that simple.

Since 1978 there have been six inversions of the yield curve.

While the above data shows yield curve inversions have accurately predicted recessions in the past, not all instances of yield curve inversions have resulted in recessions.

The 2- and 10-year yield curve has inverted 28 times since 1900, and in 22 of those instances, a recession has followed.

While an indicator that accurately predicts a recession over 75% of the time shouldn't be ignored, some material changes in recent years need to be considered.

Firstly, the Fed's manipulation of the yield curve has been well documented. I will stop short of saying this time is different, but the Feds intervention in the bond market over the prior decade suggests that a yield curve inversion may not be as valuable an indicator as it once was.

For example, we saw a yield curve inversion in August 2019, yet US stocks are up almost 70% since then. A switch to cash over this period would have meant missing out on the fastest bull run in history.

Another issue with inferring asset allocation decisions following a yield curve inversion is, even with this predictive information to hand, the alternative investment options are not as obvious as you might think. At least not across traditional asset classes.

While US stock returns for the one-year period following a yield curve inversion are lower (4.7% vs. 9.0% during all other one-year periods), the data also suggests that US Treasury Bonds will underperform US stocks over this period.

A paper from Eugene Fama and Kenneth French concluded:

"We find no evidence that inverted yield curves predict stocks will underperform Treasury bills for forecast periods of one, two, three and five years"

So, while recent data may suggest that equity markets will experience slowing growth, switching to bonds or cash is not the answer.

Stay the course.

"Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves" - Peter Lynch.

To learn how to protect your portfolio in a recession, go to theislandinvestor.com.

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Killarney for Palestine film screening

Killarney for Palestine recently held a sold-out screening of the Oscar-winning documentary ‘No Other Land’ at the West End School of Arts, raising €2,100 for Camp Breakerz. The event, which […]

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Killarney for Palestine recently held a sold-out screening of the Oscar-winning documentary ‘No Other Land’ at the West End School of Arts, raising €2,100 for Camp Breakerz.

The event, which took place on July 3, included two screenings, both of which were fully booked. Guests enjoyed cheese and wine before the shows.
‘No Other Land’ depicts the ongoing destruction in Masafer Yatta, a cluster of villages in the Southern West Bank, and shows the experiences of Palestinians under Israeli occupation. The film won in the Best Documentary category at this year’s Academy Awards.
The screenings were organised in association with the West End School of Arts.
All proceeds from the €25 tickets benefited Camp Breakerz Crew, a children’s charity based in Gaza that provides creative outlets through dance and is involved in food distribution programs in Nuseirat Camp and Deir-Al-Balah due to food shortages.
Sally MacMonagle, who recently spent time in Aida Refugee Camp in Bethlehem, also spoke at one of the screenings.

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Bid to host European Presidency summit meetings gathers pace

Fianna Fáil Spokesperson on Tourism, Michael Cahill TD, has highlighted Killarney’s suitability to host summit meetings of international Government Ministers during Ireland’s six-month European Presidency tenure in 2026. Deputy Cahill […]

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Fianna Fáil Spokesperson on Tourism, Michael Cahill TD, has highlighted Killarney’s suitability to host summit meetings of international Government Ministers during Ireland’s six-month European Presidency tenure in 2026.

Deputy Cahill believes Kerry’s available accommodation, food, and conference facilities are “second to none,” with Killarney as the central location.
“Visitors from every corner of the earth have been coming to Kerry for centuries now, to experience its beauty and serenity and have returned on many occasions because of the fabulous time they have enjoyed during their stay here,” said Deputy Cahill. “Where else would you want to bring the senior Government Ministers of all of our EU counterpart states, to experience Ireland, its customs and heritage?”
The Rossbeigh TD outlined various attractions available for visitors during downtime: “During their downtime, they can visit the Blaskets and Slea Head, Sceilg Mhichíl and the Ring of Kerry, Killarney’s Lakes, Gap of Dunloe, National Park and Sliabh Luachra, all of our glorious beaches from Ballybunion to Rossbeigh, Kells to Ventry, Whitestrand to Inch, Ballinskelligs to Cromane, Waterville to Derrynane.” He also cited Kerry’s golf courses, Listowel Writers Week, the Rose of Tralee, and Puck Fair as potential experiences.
Deputy Cahill confirmed he has raised this matter with An Taoiseach, Micheál Martin; An Tánaiste and Minister for Foreign Affairs, Simon Harris; and Minister of State for European Affairs, Thomas Byrne.
“If Killarney’s bid is successful in bringing the Heads of State to our county for meetings, conferences and functions, it will be a massive boost to the local economy in Killarney and also throughout the county,” added Cahill.”Iwill continue to push in the coming months for Killarney and Kerry to be included as bases for the rounds of meetings that are to take place from July 1 to December 312026.”

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