T-Bill/10yr Treasury Spread And Recessions

“Davidson” submits:

History from 1953 indicates that when the T-Bill/10yr Treas Rate Spread falls to 0.20% or lower a recession occurs, but not this time. The daily T-Bill/10yr Treas Rate Spread data from Jan 2012 provides insight when coupled to other economic data and media reporting.

Algorithmic trading has become a significant feature of Momentum Investor activity that was not as significant 20yrs ago. It has evolved with traders seeking advantages over other investors with momentary opportunities which require computer-driven high-speed trading. Every trader seeks a time advantage over others and every trick and head-fake are used to advantage. Once a trend develops which is too significant to ignore, all the algorithms become coordinated. This occurs because the high levels of leverage applied to algorithmic trading forces adherence to any significant trend. Falling into coordination are mathematical algorithms which without human intervention or counter interpretation read significant price trends identically. Trend followers are not Value Investors and represent only part of the investor psychology inputs to prices.

Value Investors separate trends from fundamentals. Their focus on broad economic fundamentals and individual corporate financials provides a counter influence to Momentum Investor price trend algorithms. Throughout market history, it is Value Investors who buy securities using fundamentals which Momentum Investors ignore. Value Investors are always active buyers during the period of market panic. John Templeton, a famous Value Investor, often said,

“Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.”

“The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

Knowing that this time is different for the T-Bill/10yr Treas Rate Spread in part comes from insider buying. Corporate insider accumulation (considered the most knowledgeable Value Investors) rises historically during severe market panics as equity prices are in steep discounts to future financial expectations.  John Templeton recognized this. Market and economic peaks have never occurred during periods of pessimism. The requirement of a recession and severe market correction is that investors and businesses must be over-extended through a prolonged period of investor euphoria. The term ‘over-extended’ refers to using too much leverage in business and personal borrowing such that a slowing in additional lending leads to being unable to paper-over bad debt with new lending. Defaults have always risen rapidly when an over-levered economy meets reduced lending. This condition leads to even more lending restrictions. A situation that is not present today.

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Disclosure: The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or ...

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