What is an Inverted Yield Curve?

Why are people talking about inverted yield curves?

Not sure if you have been hearing the talk about an “inverted yield curve”. But before you move onto a post that features a cat playing the piano or some skateboarder crashing and landing on his groin, it might make sense to at least understand a little of what this means.

In short, if u are putting your money in a bond, for a few months, you are offered a better ROI (interest rate return) than if it was placed in a 5-year term.

Basically, the borrower will pay you at a higher interest for having your cash for a few months than if they keep it for 5 years!!

Weird I know. But what does all this mean? And how does it affect me?

Demanding much!!!

Ok, I’ll share this. The people that measure this stuff through history, has found that when short term rates were stronger than long-term rates, on average 11-14 months later, the US economy dips into a recession. Historically, the recession also has a decline in the equity markets too.

What the experts are saying is we have this economic tsunami heading our way and we need to prepare now or find ourselves “floating out to sea” with a declining net worth.

What to do? What to do?

What’s our next move?

If you believe the projections, one option is to put your funds in cash. Literally, put the funds under your mattress and ride out the economic storm. This guarantees you will have not lost money during the next period of time, but you also won’t add value either.

Another option is to go the bond and GIC route. This is similar to having the funds in cash but they will be tied up for a longer period of time and the rate of return isn’t great.

If you are truly educated in the equity market, you can start to “short the market” and take out options. But unless you are savvy at this strategy, you can lose a lot. A little out of my league.

I personally have been going harder in the real estate market as a hedge in the equity market. Having the stock market drop by 20% won’t affect how many people want to live in the GTA.

Historically rents have not regressed in Ontario in any economic condition and I see no reason why it will this time.

Will real estate values drop during a recession. Unknown. If the Federal Government, in the midst of a recession, remove the stress test and encourage people to buy real estate to spark the economy, values would rise.

But even if the values drop another 10%, that won’t affect the rental market negatively. If fewer people can qualify for buying a property, yet the population continues to rise, and new build rentals don’t meet population growth, expect a steady rise in the rental demand.

We often refer to the real estate market as a wealth builder, but over the next few years, it might also be a great hedge against a declining equity market.