You saw the Dow drop more than 800 points Wednesday. This was due to a number of factors, but many on Wall Street point to the inversion of the yield curve.
What is an inverted yield curve? It’s what happens when yields on shorter-term Treasury notes cross below yields for longer-term Treasury notes.
On Wednesday, the spread between yields on 2-year and 10-year Treasuries briefly turned negative for the first time since 2007 — since the financial crisis.
On top of that, the yield curve is already inverted on 3-year Treasury bonds compared with the 10-year Treasury.
So, what’s it mean? An inverted yield curve means investors worry that economic headwinds such as the trade war and a slowing global economy may impact future returns.
They don’t want to make long-term investment plans. They stop buying the long end of the curve — sending rates lower — and pile all their money into the short end, sending rates higher.
There are three big effects we can expect from this.
Banks are going to get pounded. Banks typically borrow on the short end and lend on the long end of the yield curve. If long-term interest rates fall more than the short-term ones, banks earn less on lending and pay more on deposits.
To put it another way, if the yield curve is inverted, banks’ profit margin evaporates.
The Fed will cut rates again. In fact, Goldman Sachs is pretty sure that the Fed will cut rates two more times between now and the end of next year.
Recession risks are rising. TD Securities says it sees a 55% chance of a recession in the next 12 months. That’s the highest risk since 2007 — since the financial crisis!
So, what are good trades in tough times?
Trade #1: Short Financials
If banks are going to get pounded into paste, then you don’t want to own financials. And if you have an appetite for risk, you could SHORT financials.
Shorting stocks is hard. An easier way to do that is to buy the ProShares UltraShort Financials ETF (NYSE: SKF).
This ETF tracks TWICE the inverse of the daily performance of the Dow Jones U.S. Financials Index. It has an expense ratio of 0.95%. It’s for short-term trading only. While it comes with higher risks, the profit potential can be explosive.
Trade #2: Buy Gold and Miners
The Fed cutting rates again and again makes for an environment in which gold shines. Indeed, while most investments and equites are being sold hard and fast, gold and miners are both doing quite well recently.
You can see that in the last month, the S&P 500 has lost 5.66%. At the same time, gold is up 6.95% and gold miners, as tracked by the VanEck Vectors Gold Miners ETF (NYSE: GDX), is up 8.55%.
[I’m putting the finishing touches on a new trade in the metals for my newsletter subscribers. They will get it in their inboxes this coming Friday, Aug. 23. Click here to make sure your name is on my list to receive my trading signal, the moment it is ready to take action.]
Trade #3: Dividend-raisers
If bonds are yielding little or nothing — and sometimes less than nothing — then dividend-paying stocks have a chance to shine.
In fact, Ned Davis Research has shown scientifically that stocks that raise dividends outperform the broad market in bull AND bear markets.
Since 1972, S&P dividend-payers outperformed non-payers by 3.4% in each bull market. Not bad. But in bear markets, dividend-payers outperformed non-payers by 12.5%.
Nice!
I already showed this chart to my Megatrend Trader — previously Wealth Supercycle — subscribers last month, just as I recommended they lock and load on more precious metals miners and dividend-raisers, too.
It’s a winning combination for any market. And if we’re headed into a bear market, it’s even better.
I’ll tell ya, it’s hard to make heads or tails of a market that can be pushed around like a leaf in the wind by the hot air blowing out of a presidential tweetstorm.
In my Wealth Megatrends newsletter (formerly known as Wealth Supercycle), we’re hoping for the best. But we’re prepared for the worst. You should be, too.
And we’ll ring the cash register all the way, either way.
All the best,
Sean
