What An Inverted Yield Curve Means For Investors
The yield spread between 10-year and 2-year US Treasury bonds has fallen below 0.2 percent, its lowest level since March 2020. A flattening or negative yield curve can be a bad sign for the economy.
What Is An Inverted Yield Curve?
In the yield curve, bonds of equal credit quality but different maturities are plotted. The most commonly used yield curve for US investors is a plot of 2-year and 10-year Treasury yields, which have yet to invert.
A typical yield curve has higher interest rates for future maturities. In a flat yield curve, short-term and long-term yields are similar. Inverted yield curves occur when short-term yields exceed long-term yields. Inversions of yield curves have historically occurred during recessions.
Inverted yield curves have preceded each of the past eight US recessions. The good news is they're far leading indicators, meaning a recession is likely not imminent.
Every US recession since 1955 has occurred between six and 24 months after an inversion of the two-year and 10-year Treasury yield curves, according to the San Francisco Fed. So, six months before COVID-19, the yield curve inverted in August 2019.
Looking Ahead
The spread between two-year and 10-year Treasury yields was 0.18 percent on Tuesday, the smallest since before the last US recession. If the graph above continues, a two-year/10-year yield curve inversion could occur within the next few months.
According to Bank of America analyst Stephen Suttmeier, the S&P 500 typically peaks six to seven months after the 2s-10s yield curve inverts, and the US economy enters recession six to seven months later.
Investors appear unconcerned about the flattening yield curve. This is in contrast to the iShares 20+ Year Treasury Bond ETF TLT +2.19% which was down 1% on Tuesday.
Inversion of the yield curve and rising interest rates have historically harmed stocks. Recessions in the US have historically coincided with or followed the end of a Federal Reserve rate hike cycle, not the start.
More on Economics & Investing
Ray Dalio
3 years ago
The latest “bubble indicator” readings.
As you know, I like to turn my intuition into decision rules (principles) that can be back-tested and automated to create a portfolio of alpha bets. I use one for bubbles. Having seen many bubbles in my 50+ years of investing, I described what makes a bubble and how to identify them in markets—not just stocks.
A bubble market has a high degree of the following:
- High prices compared to traditional values (e.g., by taking the present value of their cash flows for the duration of the asset and comparing it with their interest rates).
- Conditons incompatible with long-term growth (e.g., extrapolating past revenue and earnings growth rates late in the cycle).
- Many new and inexperienced buyers were drawn in by the perceived hot market.
- Broad bullish sentiment.
- Debt financing a large portion of purchases.
- Lots of forward and speculative purchases to profit from price rises (e.g., inventories that are more than needed, contracted forward purchases, etc.).
I use these criteria to assess all markets for bubbles. I have periodically shown you these for stocks and the stock market.
What Was Shown in January Versus Now
I will first describe the picture in words, then show it in charts, and compare it to the last update in January.
As of January, the bubble indicator showed that a) the US equity market was in a moderate bubble, but not an extreme one (ie., 70 percent of way toward the highest bubble, which occurred in the late 1990s and late 1920s), and b) the emerging tech companies (ie. As well, the unprecedented flood of liquidity post-COVID financed other bubbly behavior (e.g. SPACs, IPO boom, big pickup in options activity), making things bubbly. I showed which stocks were in bubbles and created an index of those stocks, which I call “bubble stocks.”
Those bubble stocks have popped. They fell by a third last year, while the S&P 500 remained flat. In light of these and other market developments, it is not necessarily true that now is a good time to buy emerging tech stocks.
The fact that they aren't at a bubble extreme doesn't mean they are safe or that it's a good time to get long. Our metrics still show that US stocks are overvalued. Once popped, bubbles tend to overcorrect to the downside rather than settle at “normal” prices.
The following charts paint the picture. The first shows the US equity market bubble gauge/indicator going back to 1900, currently at the 40% percentile. The charts also zoom in on the gauge in recent years, as well as the late 1920s and late 1990s bubbles (during both of these cases the gauge reached 100 percent ).
The chart below depicts the average bubble gauge for the most bubbly companies in 2020. Those readings are down significantly.
The charts below compare the performance of a basket of emerging tech bubble stocks to the S&P 500. Prices have fallen noticeably, giving up most of their post-COVID gains.
The following charts show the price action of the bubble slice today and in the 1920s and 1990s. These charts show the same market dynamics and two key indicators. These are just two examples of how a lot of debt financing stock ownership coupled with a tightening typically leads to a bubble popping.
Everything driving the bubbles in this market segment is classic—the same drivers that drove the 1920s bubble and the 1990s bubble. For instance, in the last couple months, it was how tightening can act to prick the bubble. Review this case study of the 1920s stock bubble (starting on page 49) from my book Principles for Navigating Big Debt Crises to grasp these dynamics.
The following charts show the components of the US stock market bubble gauge. Since this is a proprietary indicator, I will only show you some of the sub-aggregate readings and some indicators.
Each of these six influences is measured using a number of stats. This is how I approach the stock market. These gauges are combined into aggregate indices by security and then for the market as a whole. The table below shows the current readings of these US equity market indicators. It compares current conditions for US equities to historical conditions. These readings suggest that we’re out of a bubble.
1. How High Are Prices Relatively?
This price gauge for US equities is currently around the 50th percentile.
2. Is price reduction unsustainable?
This measure calculates the earnings growth rate required to outperform bonds. This is calculated by adding up the readings of individual securities. This indicator is currently near the 60th percentile for the overall market, higher than some of our other readings. Profit growth discounted in stocks remains high.
Even more so in the US software sector. Analysts' earnings growth expectations for this sector have slowed, but remain high historically. P/Es have reversed COVID gains but remain high historical.
3. How many new buyers (i.e., non-existing buyers) entered the market?
Expansion of new entrants is often indicative of a bubble. According to historical accounts, this was true in the 1990s equity bubble and the 1929 bubble (though our data for this and other gauges doesn't go back that far). A flood of new retail investors into popular stocks, which by other measures appeared to be in a bubble, pushed this gauge above the 90% mark in 2020. The pace of retail activity in the markets has recently slowed to pre-COVID levels.
4. How Broadly Bullish Is Sentiment?
The more people who have invested, the less resources they have to keep investing, and the more likely they are to sell. Market sentiment is now significantly negative.
5. Are Purchases Being Financed by High Leverage?
Leveraged purchases weaken the buying foundation and expose it to forced selling in a downturn. The leverage gauge, which considers option positions as a form of leverage, is now around the 50% mark.
6. To What Extent Have Buyers Made Exceptionally Extended Forward Purchases?
Looking at future purchases can help assess whether expectations have become overly optimistic. This indicator is particularly useful in commodity and real estate markets, where forward purchases are most obvious. In the equity markets, I look at indicators like capital expenditure, or how much businesses (and governments) invest in infrastructure, factories, etc. It reflects whether businesses are projecting future demand growth. Like other gauges, this one is at the 40th percentile.
What one does with it is a tactical choice. While the reversal has been significant, future earnings discounting remains high historically. In either case, bubbles tend to overcorrect (sell off more than the fundamentals suggest) rather than simply deflate. But I wanted to share these updated readings with you in light of recent market activity.
Quant Galore
3 years ago
I created BAW-IV Trading because I was short on money.
More retail traders means faster, more sophisticated, and more successful methods.
Tech specifications
Only requires a laptop and an internet connection.
We'll use OpenBB's research platform for data/analysis.
Pricing and execution on Options-Quant
Background
You don't need to know the arithmetic details to use this method.
Black-Scholes is a popular option pricing model. It's best for pricing European options. European options are only exercisable at expiration, unlike American options. American options are always exercisable.
American options carry a premium to cover for the risk of early exercise. The Black-Scholes model doesn't account for this premium, hence it can't price genuine, traded American options.
Barone-Adesi-Whaley (BAW) model. BAW modifies Black-Scholes. It accounts for exercise risk premium and stock dividends. It adds the option's early exercise value to the Black-Scholes value.
The trader need not know the formulaic derivations of this model.
https://ir.nctu.edu.tw/bitstream/11536/14182/1/000264318900005.pdf
Strategy
This strategy targets implied volatility. First, we'll locate liquid options that expire within 30 days and have minimal implied volatility.
After selecting the option that meets the requirements, we price it to get the BAW implied volatility (we choose BAW because it's a more accurate Black-Scholes model). If estimated implied volatility is larger than market volatility, we'll capture the spread.
(Calculated IV — Market IV) = (Profit)
Some approaches to target implied volatility are pricey and inaccessible to individual investors. The best and most cost-effective alternative is to acquire a straddle and delta hedge. This may sound terrifying and pricey, but as shown below, it's much less so.
The Trade
First, we want to find our ideal option, so we use OpenBB terminal to screen for options that:
Have an IV at least 5% lower than the 20-day historical IV
Are no more than 5% out-of-the-money
Expire in less than 30 days
We query:
stocks/options/screen/set low_IV/scr --export Output.csv
This uses the screener function to screen for options that satisfy the above criteria, which we specify in the low IV preset (more on custom presets here). It then saves the matching results to a csv(Excel) file for viewing and analysis.
Stick to liquid names like SPY, AAPL, and QQQ since getting out of a position is just as crucial as getting in. Smaller, illiquid names have higher inefficiencies, which could restrict total profits.
We calculate IV using the BAWbisection model (the bisection is a method of calculating IV, more can be found here.) We price the IV first.
According to the BAW model, implied volatility at this level should be priced at 26.90%. When re-pricing the put, IV is 24.34%, up 3%.
Now it's evident. We must purchase the straddle (long the call and long the put) assuming the computed implied volatility is more appropriate and efficient than the market's. We just want to speculate on volatility, not price fluctuations, thus we delta hedge.
The Fun Starts
We buy both options for $7.65. (x100 multiplier). Initial delta is 2. For every dollar the stock price swings up or down, our position value moves $2.
We want delta to be 0 to avoid price vulnerability. A delta of 0 suggests our position's value won't change from underlying price changes. Being delta-hedged allows us to profit/lose from implied volatility. Shorting 2 shares makes us delta-neutral.
That's delta hedging. (Share price * shares traded) = $330.7 to become delta-neutral. You may have noted that delta is not truly 0.00. This is common since delta-hedging means getting as near to 0 as feasible, since it is rare for deltas to align at 0.00.
Now we're vulnerable to changes in Vega (and Gamma, but given we're dynamically hedging, it's not a big risk), or implied volatility. We wanted to gamble that the position's IV would climb by at least 2%, so we'll maintain it delta-hedged and watch IV.
Because the underlying moves continually, the option's delta moves continuously. A trader can short/long 5 AAPL shares at most. Paper trading lets you practice delta-hedging. Being quick-footed will help with this tactic.
Profit-Closing
As expected, implied volatility rose. By 10 minutes before market closure, the call's implied vol rose to 27% and the put's to 24%. This allowed us to sell the call for $4.95 and the put for $4.35, creating a profit of $165.
You may pull historical data to see how this trade performed. Note the implied volatility and pricing in the final options chain for August 5, 2022 (the position date).
Final Thoughts
Congratulations, that was a doozy. To reiterate, we identified tickers prone to increased implied volatility by screening OpenBB's low IV setting. We double-checked the IV by plugging the price into Options-BAW Quant's model. When volatility was off, we bought a straddle and delta-hedged it. Finally, implied volatility returned to a normal level, and we profited on the spread.
The retail trading space is very quickly catching up to that of institutions. Commissions and fees used to kill this method, but now they cost less than $5. Watching momentum, technical analysis, and now quantitative strategies evolve is intriguing.
I'm not linked with these sites and receive no financial benefit from my writing.
Tell me how your experience goes and how I helped; I love success tales.
Ben Carlson
3 years ago
Bear market duration and how to invest during one
Bear markets don't last forever, but that's hard to remember. Jamie Cullen's illustration
A bear market is a 20% decline from peak to trough in stock prices.
The S&P 500 was down 24% from its January highs at its low point this year. Bear market.
The U.S. stock market has had 13 bear markets since WWII (including the current one). Previous 12 bear markets averaged –32.7% losses. From peak to trough, the stock market averaged 12 months. The average time from bottom to peak was 21 months.
In the past seven decades, a bear market roundtrip to breakeven has averaged less than three years.
Long-term averages can vary widely, as with all historical market data. Investors can learn from past market crashes.
Historical bear markets offer lessons.
Bear market duration
A bear market can cost investors money and time. Most of the pain comes from stock market declines, but bear markets can be long.
Here are the longest U.S. stock bear markets since World war 2:
Stock market crashes can make it difficult to break even. After the 2008 financial crisis, the stock market took 4.5 years to recover. After the dotcom bubble burst, it took seven years to break even.
The longer you're underwater in the market, the more suffering you'll experience, according to research. Suffering can lead to selling at the wrong time.
Bear markets require patience because stocks can take a long time to recover.
Stock crash recovery
Bear markets can end quickly. The Corona Crash in early 2020 is an example.
The S&P 500 fell 34% in 23 trading sessions, the fastest bear market from a high in 90 years. The entire crash lasted one month. Stocks broke even six months after bottoming. Stocks rose 100% from those lows in 15 months.
Seven bear markets have lasted two years or less since 1945.
The 2020 recovery was an outlier, but four other bear markets have made investors whole within 18 months.
During a bear market, you don't know if it will end quickly or feel like death by a thousand cuts.
Recessions vs. bear markets
Many people believe the U.S. economy is in or heading for a recession.
I agree. Four-decade high inflation. Since 1945, inflation has exceeded 5% nine times. Each inflationary spike caused a recession. Only slowing economic demand seems to stop price spikes.
This could happen again. Stocks seem to be pricing in a recession.
Recessions almost always cause a bear market, but a bear market doesn't always equal a recession. In 1946, the stock market fell 27% without a recession in sight. Without an economic slowdown, the stock market fell 22% in 1966. Black Monday in 1987 was the most famous stock market crash without a recession. Stocks fell 30% in less than a week. Many believed the stock market signaled a depression. The crash caused no slowdown.
Economic cycles are hard to predict. Even Wall Street makes mistakes.
Bears vs. bulls
Bear markets for U.S. stocks always end. Every stock market crash in U.S. history has been followed by new all-time highs.
How should investors view the recession? Investing risk is subjective.
You don't have as long to wait out a bear market if you're retired or nearing retirement. Diversification and liquidity help investors with limited time or income. Cash and short-term bonds drag down long-term returns but can ensure short-term spending.
Young people with years or decades ahead of them should view this bear market as an opportunity. Stock market crashes are good for net savers in the future. They let you buy cheap stocks with high dividend yields.
You need discipline, patience, and planning to buy stocks when it doesn't feel right.
Bear markets aren't fun because no one likes seeing their portfolio fall. But stock market downturns are a feature, not a bug. If stocks never crashed, they wouldn't offer such great long-term returns.
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DC Palter
3 years ago
How Will You Generate $100 Million in Revenue? The Startup Business Plan
A top-down company plan facilitates decision-making and impresses investors.
A startup business plan starts with the product, the target customers, how to reach them, and how to grow the business.
Bottom-up is terrific unless venture investors fund it.
If it can prove how it can exceed $100M in sales, investors will invest. If not, the business may be wonderful, but it's not venture capital-investable.
As a rule, venture investors only fund firms that expect to reach $100M within 5 years.
Investors get nothing until an acquisition or IPO. To make up for 90% of failed investments and still generate 20% annual returns, portfolio successes must exit with a 25x return. A $20M-valued company must be acquired for $500M or more.
This requires $100M in sales (or being on a nearly vertical trajectory to get there). The company has 5 years to attain that milestone and create the requisite ROI.
This motivates venture investors (venture funds and angel investors) to hunt for $100M firms within 5 years. When you pitch investors, you outline how you'll achieve that aim.
I'm wary of pitches after seeing a million hockey sticks predicting $5M to $100M in year 5 that never materialized. Doubtful.
Startups fail because they don't have enough clients, not because they don't produce a great product. That jump from $5M to $100M never happens. The company reaches $5M or $10M, growing at 10% or 20% per year. That's great, but not enough for a $500 million deal.
Once it becomes clear the company won’t reach orbit, investors write it off as a loss. When a corporation runs out of money, it's shut down or sold in a fire sale. The company can survive if expenses are trimmed to match revenues, but investors lose everything.
When I hear a pitch, I'm not looking for bright income projections but a viable plan to achieve them. Answer these questions in your pitch.
Is the market size sufficient to generate $100 million in revenue?
Will the initial beachhead market serve as a springboard to the larger market or as quicksand that hinders progress?
What marketing plan will bring in $100 million in revenue? Is the market diffuse and will cost millions of dollars in advertising, or is it one, focused market that can be tackled with a team of salespeople?
Will the business be able to bridge the gap from a small but fervent set of early adopters to a larger user base and avoid lock-in with their current solution?
Will the team be able to manage a $100 million company with hundreds of people, or will hypergrowth force the organization to collapse into chaos?
Once the company starts stealing market share from the industry giants, how will it deter copycats?
The requirement to reach $100M may be onerous, but it provides a context for difficult decisions: What should the product be? Where should we concentrate? who should we hire? Every strategic choice must consider how to reach $100M in 5 years.
Focusing on $100M streamlines investor pitches. Instead of explaining everything, focus on how you'll attain $100M.
As an investor, I know I'll lose my money if the startup doesn't reach this milestone, so the revenue prediction is the first thing I look at in a pitch deck.
Reaching the $100M goal needs to be the first thing the entrepreneur thinks about when putting together the business plan, the central story of the pitch, and the criteria for every important decision the company makes.
Jeff John Roberts
3 years ago
Jack Dorsey and Jay-Z Launch 'Bitcoin Academy' in Brooklyn rapper's home
The new Bitcoin Academy will teach Jay-Marcy Z's Houses neighbors "What is Cryptocurrency."
Jay-Z grew up in Brooklyn's Marcy Houses. The rapper and Block CEO Jack Dorsey are giving back to his hometown by creating the Bitcoin Academy.
The Bitcoin Academy will offer online and in-person classes, including "What is Money?" and "What is Blockchain?"
The program will provide participants with a mobile hotspot and a small amount of Bitcoin for hands-on learning.
Students will receive dinner and two evenings of instruction until early September. The Shawn Carter Foundation will help with on-the-ground instruction.
Jay-Z and Dorsey announced the program Thursday morning. It will begin at Marcy Houses but may be expanded.
Crypto Blockchain Plug and Black Bitcoin Billionaire, which has received a grant from Block, will teach the classes.
Jay-Z, Dorsey reunite
Jay-Z and Dorsey have previously worked together to promote a Bitcoin and crypto-based future.
In 2021, Dorsey's Block (then Square) acquired the rapper's streaming music service Tidal, which they propose using for NFT distribution.
Dorsey and Jay-Z launched an endowment in 2021 to fund Bitcoin development in Africa and India.
Dorsey is funding the new Bitcoin Academy out of his own pocket (as is Jay-Z), but he's also pushed crypto-related charitable endeavors at Block, including a $5 million fund backed by corporate Bitcoin interest.
This post is a summary. Read full article here
Alex Bentley
3 years ago
Why Bill Gates thinks Bitcoin, crypto, and NFTs are foolish
Microsoft co-founder Bill Gates assesses digital assets while the bull is caged.
Bill Gates is well-respected.
Reasonably. He co-founded and led Microsoft during its 1980s and 1990s revolution.
After leaving Microsoft, Bill Gates pursued other interests. He and his wife founded one of the world's largest philanthropic organizations, Bill & Melinda Gates Foundation. He also supports immunizations, population control, and other global health programs.
When Gates criticized Bitcoin, cryptocurrencies, and NFTs, it made news.
Bill Gates said at the 58th Munich Security Conference...
“You have an asset class that’s 100% based on some sort of greater fool theory that somebody’s going to pay more for it than I do.”
Gates means digital assets. Like many bitcoin critics, he says digital coins and tokens are speculative.
And he's not alone. Financial experts have dubbed Bitcoin and other digital assets a "bubble" for a decade.
Gates also made fun of Bored Ape Yacht Club and NFTs, saying, "Obviously pricey digital photographs of monkeys will help the world."
Why does Bill Gates dislike digital assets?
According to Gates' latest comments, Bitcoin, cryptos, and NFTs aren't good ways to hold value.
Bill Gates is a better investor than Elon Musk.
“I’m used to asset classes, like a farm where they have output, or like a company where they make products,” Gates said.
The Guardian claimed in April 2021 that Bill and Melinda Gates owned the most U.S. farms. Over 242,000 acres of farmland.
The Gates couple has enough farmland to cover Hong Kong.
Bill Gates is a classic investor. He wants companies with an excellent track record, strong fundamentals, and good management. Or tangible assets like land and property.
Gates prefers the "old economy" over the "new economy"
Gates' criticism of Bitcoin and cryptocurrency ventures isn't surprising. These digital assets lack all of Gates's investing criteria.
Volatile digital assets include Bitcoin. Their costs might change dramatically in a day. Volatility scares risk-averse investors like Gates.
Gates has a stake in the old financial system. As Microsoft's co-founder, Gates helped develop a dominant tech company.
Because of his business, he's one of the world's richest men.
Bill Gates is invested in protecting the current paradigm.
He won't invest in anything that could destroy the global economy.
When Gates criticizes Bitcoin, cryptocurrencies, and NFTs, he's suggesting they're a hoax. These soapbox speeches are one way he protects his interests.
Digital assets aren't a bad investment, though. Many think they're the future.
Changpeng Zhao and Brian Armstrong are two digital asset billionaires. Two crypto exchange CEOs. Binance/Coinbase.
Digital asset revolution won't end soon.
If you disagree with Bill Gates and plan to invest in Bitcoin, cryptocurrencies, or NFTs, do your own research and understand the risks.
But don’t take Bill Gates’ word for it.
He’s just an old rich guy with a lot of farmland.
He has a lot to lose if Bitcoin and other digital assets gain global popularity.
This post is a summary. Read the full article here.