Yield Curves, China and ESG
What is an inverted yield curve and is it bad? You may want to get a lawnmower because we are going into the weeds here…
Well, let’s just start with an explanation of what “yield” is.
Yield is just a fancy way of saying interest rates. Bankers like to say things like “I say, Winthrop, it certainly appears that yields for the 10-year note are increasing, don’t you know?” and we nod our heads and discuss which Napa Valley wine harvest was the best year for Cabernet.
Normal folks say “Nuts – mortgage interest rates went from 3.9% to 5% almost overnight – there is no freaking way I am qualifying for that home loan!!”.
Yep, yield is just another word for interest rates.
Now let’s define what “curve” means.
Interest rates generally increase the further out your loan or investment goes with time.
Your 15-year loan will have a lower rate than a 30-year loan.
Your average one-year line of credit will have a lower rate than a 5-year loan.
This is because the longer you go out, the higher the chance that a borrower will default, so the cost for doing the loan needs to be higher as the length of the loan increases.
It’s the same thing with savings and investing.
If you are getting a 1-year Certificate of Deposit, the interest the bank pays will be less than a 2-year CD, which will be lower than a 5-year CD.
The same is true of government bonds, or investments.
A 6-month treasury will pay a lower interest rate – yield – than a 12-month treasury bill, which will pay a lower rate than a 5-year treasury note which will be less than a 10-year note and so on.
In other words, as the investment goes out in time, the interest rate you receive will increase because the investor – you – should to be compensated for tying up your money for longer periods.
Unless it is an inverted yield – interest rate - curve.
An inverted yield curve starts going up in a normal fashion where the 12-month is higher than the 6-month which is higher than the 3-month, and the two-year is higher than the one-year and so on.
Earlier this month, the 3-year treasury had a rate of 2.61% with the 5, 7 and 10-year treasury investments having rates of 2.55%, 2.50%, and 2.39% respectively.
The 3-year was higher than the 10-year – it was inverted – Gasp!
This means that bond investors believe that short-term rates will be higher than long-term rates for the next few years.
This is precisely what happens when the fed raises rates to cool off the economy. Short term rates go up and it may be enough of an impact that it sends short term rates higher than long term rates.
And… so what, you say?
Well, all recessions (since 1970) have been preceded by an inverted yield curve. But not all inverted curves have been followed by a recession, but most have.
This is not to say that inverted yield curves cause recessions. But they are a very good indicator of what is to come.
Bottom line, it may be wise to build a “What if we have a recession” chapter into your business plan. That way you will be prepared if it happens.
That was long – on to shorter topics.
China: When is the commune concept even too much for the commune-ists?
In 2021, “Common Prosperity” was the go-to phrase for China’s leadership, aimed at redistributing more of China’s wealth amid concerns that elites had overly benefitted from the economic boom.
This was a way for President Xi Jinping to start bringing the country back to its Chairman Mao roots.
This year, it has turned up only once in official speeches.
Evidently, even communists need their economy to grow and if you take away the fruits of one’s labors, there tends to be less fruit no matter how much you try to distribute the slices.
What is this ESG thing you may have heard about? It stands for Environmental, Social and Governance investing.
Basically, an ESG portfolio of stocks is comprised of companies that have been scored as environmentally, socially or governmentally acceptable by someone who feels they have a moral compass better than everyone else.
They create something called an ESG rating.
The problem is that the rating kind of depends on their definition of ‘moral’. As well as the direction of the portfolio manager’s compass.
As an example, companies with significant operations in Russia before the invasion had higher ESG and human rights scores than companies that were not in Russia – well, that’s a bit odd, isn’t it?
And then the first ones out of Russia were the ones that also had the low ESG scores; the higher ESG stocks took a little longer to vacate – but if they had a much higher moral score, why would they hem and haw about leaving Russia?
Peculiar, this ESG rating.
The problem is, some investors believe the ratings and invest – or don’t invest – depending on if the stock belongs to a company that has a higher ESG score and is “doing good”.
The problem with trying to “do good” basically brings the emotion into investing. That’s fine, as long as you are ok with not getting the return you expect.
At the end of the day, a stock may be purchased because it makes folks warm and fuzzy but ultimately, it should generate a return for the shareholder. That’s something that will make your 401(k) feel good.
If you want to feel like you are supporting a good cause, there are plenty of non-profits you can donate to. Here are a few in the IE:
