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RVB's Market Musings

What began here as an avenue to interact and learn has far exceeded those goals.

If you are a prospective employer, please consider this site a place where you can see my passion for investing...

Thursday, December 29, 2005

Oh No! The Yield Curve Inverted?

That's an acronym for what I really want to say. Let's not panic. First, it was inverted by 2 freakin' basis points at the close on Tuesday. Whoop-dee-doo.

Second, the yield curve has done this before. Check out September 1998 when the 2-yr and 5-yr bond yield were slightly less than a 3-month T-Bill. What happened? The market CRASHED. TWO YEARS LATER.

So let's just look at this curve as flat. Is it more like 1994? I believe so. In 1994 the curve was flat for a period of time. The market was flat for virtually a year and then in complete John Madden form, BOOM! Off to the moon for the bull market of 1995-2000. Living yield curve on Smartmoney

To take this a bit further, let's ask WHY the curve is flat? Why isn't the 10 year moving upward? Could it be that investors believe that inflation has been curbed and there is no longer an added risk premium required on longer term bonds? I think that's certainly part of the equation here. Rates are still low. And I think the Fed is stopping at 4.75 or 5. Home prices aren't going to collapse. It'll slow and the Fed will be happy.

Are we headed to a recession? YES! But I say this half in jest, because the certainty of a recession, someday, is as certain that you and I will die, someday. The question is, WHEN? It's not that close, at least not in my mind. Stocks are cheap, and companies are making money. They have alot of cash and don't need to borrow. Could that also be what's leading to low longer-term rates? Maybe, but they tend to operate at the shorter end of the curve, so who knows?

What about the fact that the rates are simply just still low? Does paying 7.5% on your car seem that terrible? I don't think so...so perhaps demand is still high on long-term loans? Then, if that's the case, prices on the long end are still high, and that would mean rates stay low.

The point is, let's not panic just yet.


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