The Big Picture: The Trouble with Sentiment
While the economy seems to be shaking off a poor start to the year, there’s trouble on the horizon. Sentiment indicators show that investors are getting bullish again.
Yet a key indicator continues to strongly hint at a recession in the next year. It may simply be a further continuation of declining GDP numbers as we’ve seen so far this year. Or it may come from a more severe move.
The indicator? An inverted yield curve. Currently, investors can earn more on a 2-year US Treasury bond than on a 10-year Treasury bond. Typically, the curve rises. Investors willing to lock up money for a longer period of time should be paid more for the risk.
Historically, this curve inversion has been good at predicting recessions 12-18 months before the market realizes we’re in one. That makes it a strong indicator. And right now, this indicator is at its steepest inversion since 2008.
Ultimately, this comes down to how human beings tend to be off in their estimates. When things are going well, people tend to overestimate. When markets are down, people get pessimistic.
With the recent market rally, investors may be too optimistic going into some continued tough times in the next year. However, such a recession may be mild given current conditions.