Party like it’s (almost) 1999

I was listening to Sirius XM the other day, and often when I’m rolling through the “70’s on 7” and “80’s on 8” stations I find myself apologizing to my offspring about how bad the music was back then. But then you hear a classic like Prince’s “Let’s Go Crazy” from 1984, or so many of Aerosmith’s songs from the 70’s, and you remember that there were great songs back then.  Another big hit from prince was “1999”, which was also recorded in the 80’s.  And just as the song directs us to party like it’s 1999, we should heed that advice.

I remind myself of this, because I’ve experienced muted returns from having been a little too defensive in my portfolio, including a whipsaw in gold which has really dropped off over the summer; though there does seem to be a slight recovery in the yellow metal with news of inflation in a rising CPI, some currency fluctuations, and the ongoing threat of global instability thanks to the current administration.

In other words, I stopped letting my portfolio party a little too soon. 

The indicators I had been wary of: high valuations with the S&P 500 PE ratio at over 25 putting it at almost the 4th highest point since they starting tracking it in the 1800’s, and the Shiller version of this same ratio at the 2nd highest point ever (last time it was higher was in 2000), a protectionist administration that looks a lot like Hoover, and a flattening Yield Curve.

A lot has been recently written on the topic of the yield curve. The stories typically underline the descriptive nature of this measure of the cost of government debt vs. maturity, in relation to the economic outlook: sloped is healthy, flat is not, and negative is recessionary. There’s little contention over the truthfulness of the indicator, only debate re: aspects of its predictive ability. I’d contend that for most of us, whether the 2-10 hitting a negative .25 point threshold is less in vogue than the 1-10yr spread with a 4 week inversion, the bigger takeaway is that the smarter guys in the market – the debt guys who need to worry about the value of money 30 years from now – are saying that the economy is cooling, and that the longer-term prospects for an invested dollar are becoming relatively less attractive.

When the 10-2 spread goes negative, sell-offs and recessions follow

In 1999, the ‘2-10’ spread, or the difference between the 10 year T-Note yield less the yield of the 1 year T-Note, was going negative, which meant we had about a year to go before the equity party was over.  As you can see in this chart from the Federal Reserve Bank of St. Louis, historically there’s a year lag between the indicator hitting zero and the stock market tanking (‘Black Monday’ 1989, Dot Com crash of 2000, 2008 meltdown), and a little longer before the economy enters a recession. 

As of this writing, the yield curve is showing a 33 basis point spread between the 2 and 10 years, so we’re close to a flat curve and that important crossover, but not there yet.

Timing is key.  In 1999, the market ran up almost another 26% to its peak in 2000. 

So for your investment portfolio, don’t get too defensive, too soon.  And party like it’s almost 1999.  

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