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As stocks regain their footing, an ominous sign looms

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How investors can prepare for trouble in bond market

In recent months, one of the key themes across the fixed income market, the equity market and beyond is the dreaded “I” word: inversion.

More specifically, investors are watching out for a potential yield curve inversion, or when shorter-dated bond yields cross above their longer-dated counterparts.

Chad Morganlander, portfolio manager at Washington Crossing Advisors, told CNBC’s “Trading Nation” on Tuesday that he’s keeping a close eye on what a potential inversion could mean for the market and how investors should prepare.

Here’s what he said.

An inverted spread between the 2- and 10-year yields has been a relatively reliable economic recession predictor in recent years, with a lead time of around 12 to 18 months. In other words, an inverted curve has reliably predicated slowdowns in U.S. growth.

• We anticipate this occurring in the next six to nine months as the Federal Reserve remains on a path to interest rate normalization, bumping the 2-year yield higher as the 10-year yield fails to keep the same pace.

• Investors would be prudent to stick with names that experience relatively little volatility, backing away from more speculative assets in portfolios.

Bottom line: As the yield curve keeps flattening, an inversion becomes more likely, and Morganlander is suggesting going with less volatile names in equity portfolios.

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