Monday, January 23, 2006

Investing versus Speculating: Continued.

Investing versus Speculating: Continued.

To follow up on my blog of 15/01/06 "Investing versus Speculating" , here is a good example of financial "experts" who claim to be able to predict future economic events. This time, the subject is the current yield inversion in the bond markets, supposedly an indicator of a coming economic recession. [If you don't know what a yield curve is, just read the article, as one thing it does accomplish is to explain the idea reasonably clearly.]

Onebornfree's Commentary [followed by article]:

This is just another attempt to predict future economic events. Although yield inversions have a fair record, they are not foolproof predictors of recessions. A properly balanced long term savings plan which allows for losses occurring via unforseen recessions [ the event supposedly predicted via bond yield inversons], and other unforseeable economic events , although not 100% infallible, has to be a lot safer bet than simply speculating on a recession by throwing all of your savings into 90 day t-bills or AA+ rated corporate bonds[ or whatever] for the duration.

If you believe a recession is imminent [for whatever reason] place your bet with money you can afford to lose, if you have any.

The article, from the Sovereign Society's [ ] free email advisory named "The A-Letter":

"Dangers of Bond Market Inversion in 2006

Today's guest comment is by Eric Roseman, a member of the Sovereign Society Council of Experts and editor of Renegade Investor.

Dear A-Letter Reader:

Over the last two years, investors have barely kept pace with inflation in benchmark intermediate term US Treasury bonds. After enjoying a massive rally since 2000, bond yields hit a 40 year low in 2003 at 3.3%. Despite thirteen Federal Reserve rate hikes since June 2004, bond yields have actually declined twenty basis points (0.20%), a worrisome signal Chairman Greenspan called a "conundrum" last fall. Yield curve inversion is a dangerous anomaly because it portends to economic weakness; the last three inversions all resulted in economic recessions.

Indeed, the bond market might be signaling big trouble for the US economy in 2006. The benchmark yield curve, or the difference between the two-year and ten-year Treasury yields, inverted in late December. An inverted yield curve occurs when short-term interest rates yield more than long-term interest rates. This phenomenon is a rarity in bond markets and typically indicates that bond investors think the US Federal Reserve is tightening the monetary screws too aggressively. If this is the case, then there is a good chance that the United States might suffer a recession later this year, especially if the yield curve stays inverted.

Historically, US Treasury bonds have positively correlated to common stocks. In market history, that relationship did sever during the Great Depression as stocks collapsed from 1929 to 1932 while bonds surged. Another break in that relationship developed in the post 1997 era as the Asian economic crisis and the near demise of hedge fund Long Term Capital Management drove investors into Treasury bonds en masse. In fact, since 1997, every time the stock market has corrected sharply, Treasury bonds have provided a negative correlation to equities. This means that T-bonds potentially serve as an ideal asset allocation tool amid market mayhem, protecting portfolios.

If yield curve inversion continues through the first quarter of 2006, investors would be well advised to purchase long-term Treasury bonds. An inverted yield curve spells big trouble for corporate earnings; an investment allocation to bonds would offset any stock market losses ahead of a major economic downturn or bear market.

Bonds did a great job protecting capital during the last bear market from 2000 to 2002. I expect this relationship will repeat itself this year if yield curve inversion continues.

ERIC N. ROSEMAN, Montreal, Quebec
Editor, Renegade Investor
Web site:" [end of article]

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