Like a bad penny, another yield curve inversion appeared on Friday amid ongoing fears the U.S. is sliding into an economic slowdown. While this is typically seen as a fairly reliable sign of an impending recession, financial experts say there's no need to panic, especially if you're a younger investor.
First, you need to understand what's going on. On Friday, Aug. 23, the yield on the benchmark 10-year Treasury note again dipped below that of the 2-year U.S. note. It's the fourth day that's happened over the past two weeks, with the first of such inversions occurring on Aug. 14. This is generally considered a worrisome sign because that means people are willing to take less interest for a long-term investment than a short-term one.
"Every single recession has been preceded by a yield curve inversion," says Josh Brown, CEO of Ritholtz Wealth Management and CNBC contributor.
On Aug. 21, the yield on the benchmark 10-year Treasury note fell below that of the 2-year rate for the second day.
Almost every portfolio has some type of investment in bonds, which is a loan made to companies, municipalities and the U.S. federal government. A U.S. Treasury is a type of government bond.
A yield curve is a tool that experts use to track the bond market. It's typically shown as a graph that illustrates the relationship between the interest rate and the time until U.S. Treasury bonds mature.
In a healthy bond market scenario, the yield curve graph generally slopes upward. But when investors begin to worry about a market slowdown, the yield curve will slope downward and, in some cases, flip or invert. During the current inversion, the 10-year Treasury yield line is lower the 2-year note yield (see graph above).
It may help to think of bonds like CDs. You would expect to earn more interest from your bank on a 10-year CD than a 2-year CD. If you get paid more for the 2-year CD, it would be weird. That's true too of U.S. Treasury notes.
"That is not the way capitalism is supposed to work," Brown tells CNBC Make It. "When you lend money for a longer period of time, you're supposed to get a higher interest rate than when you lend money for a shorter time."
Yield curve inversions typically happen because people are less confident in the future and are seeking relatively safer investments like bonds. In this case, the U.S.-China trade dispute and market volatility are big factors in the shift.
Millennials (ages 23 to 38) and Gen Z (ages 7 to 22) have a long time horizon for their investments. Most have decades before they retire, so even if a recession hits tomorrow or next year, there's plenty of time for those investments to bounce back. Recessions and market downturns are part of a normal, healthy market cycle.
In fact, Brown says younger investors should welcome a recession. That's because younger investors typically do not have a big lump sum already invested in the market, so they won't take a huge hit. And they have time to let their investments bounce back.
"Real long term investors know that you can't time the market," financial coach Ramit Sethi, author of the bestselling book "I Will Teach You to Be Rich," tells CNBC Make It. "Success is about time in the market. That means every month, consistently and automatically, you are saving. You are investing. "
If you keep making contributions to your 401(k)s every two weeks, you're purchasing investments at lower prices during a market downturn.
"The absolute best thing that can happen for younger investors would be a stock market that does nothing but drops," Brown says.
There's a chain reaction across every asset class when an inverted yield curve happens, Brown says. But that doesn't mean investors should panic thinking a recession will hit tomorrow.
"Even if you told me the moment the yield curve was going to invert, that still wouldn't help me with my investments," Brown says. There's no way to know exactly how long after a yield curve inversion occurs that the markets will actually drop into a recession.
While the inversion of 10-year Treasury yield and the 2-year note has preceded every recession so far, those recessions did not happen immediately. The last time the yield curve inverted, in December 2005, the following recession did not start until December 2007, 24 months later, according to research from Ben Carlson of Ritholtz Wealth Management. On average, he found there' s a 17-month lag between the inversion and a recession.
Not only did a recession not occur right away, but the market typically sees a boost in returns following an inverted yield curve. The average return of the S&P 500 over the past five yield curve inversions has been over 15%, with just one downturn, the dot-com bust, following the February 2000 inversion.
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