Dear Reader,
Every recession in the past 60 years has been preceded by an inversion of the yield curve between the 3-month and 10-year Treasury securities – when short-term interest rates exceed long-term rates.
The yield curve is inverted now, and not just in the US.
When the yield curve inverts, recessions are likely to occur within 6 to 18 months and the pain can be felt for months to years.
Now, inverted yields can’t predict the depth and breadth of a recession, but as a tool, it can forewarn us of future conditions.
I follow the yield curve inversion because the pattern is consistent in telling us when bad news is coming, but there are other consistent patterns that we can focus on to profit in the short term.
I’m going to show you today how you can profit by monitoring other consistent patterns that occur in stock trends.
The Cause of Inverted Yield Curves
Generally, the yield curve slopes up, meaning short-term interest rates are lower than long-term rates. However, when the Federal Reserve increases the federal funds rate, there is a ripple effect as short-term rates begin to rise above long-term rates.
In the image below you can see the “normal” yield curve on the left, and an inverted curve on the right – where short-term rates rise above long-term rates.
Now that you can see what an inverted yield curve looks like, let’s take a look at another graph that illustrates what happens to economies when the yields become inverted by increased short-term rates by the Federal Reserve.
In the image below, the vertical gray lines represent recessions, while the trend line indicates rising and falling short-term rates driven by fed policy.
In every instance since the 1980’s, increasing the Fed Funds effective rate has been followed by a recession. On the far right side of the graph (current year) you can see the Federal Funds Effective Rate on the rise again.
It looks like rough roads ahead for as we’re seeing an inversion of yields in the US – and the gauge measuring the world-wide yield curve has inverted for the first time in at least two decades as well.
While the inverted yield curve may “predict” a recession, it can’t tell us how wide and how deep the recession might be.
So, let’s talk about other predictive indicators we can use to make profits whether we’re heading for a recession or not.
The Predictive Behavior of Moving Average Lines
I don’t have control over the economic conditions we’re subject to, so instead I look for ways to make profits regardless of the market and economic situations that befall us.
Just like yield curves, moving average crossovers can be predictive – they point the direction of the new trend.
The first two lines of code in my software I use for trading include two moving average lines: the 10-day and 30-day.
Let me show you why these two lines (although I also use others) are so important to my trading.
I’ve been using and teaching the impact of moving average line crossovers for decades, and the chart below is an illustration of the power these crossovers have.
The exchange traded fund, SPY, is represented in the graph above, and, so far this year, I’ve highlighted eight occurrences where the 10-period simple moving average line (red) crosses above or below the 30-period simple moving average line (blue) – indicating either bullish and bearish trend reversals.
Essentially, when the 10-period crosses above (bullish) or below (bearish) the 30-period line, the crossover indicates the potential for trend reversal – changing from bearish to bullish or vice versa.
You can see from the chart that the new trend has followed through for nearly 88% of the occurrences on this chart – and those are king of odds I can get excited about.
The reason I use repeatable patterns like the one shown here is because it’s possible to improve your trading success rate – if it weren’t so, I would have abandoned the indicator long ago.
Of course, the moving average line crossovers are not the only tool I have in my box – there are other “filters” I’ll combine with my tools in order to stack the odds of successful trading even higher.
You can always learn more about my trading tools and strategies in my weekly discussions. Just be sure to join in the discussions to find out what’s in store as we move closer to the next recession.
Until next time,
Tom Gentile
America’s #1 Pattern Trader
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