As I’ve explained in my book, “Dow to Drop 80% Soon?” one of the best predictors of a recession is a negative yield curve. The yield curve is inverted when long term yields are lower than short term yields. The yield curve inverted just prior to every U.S. recession in the past 50 years.
As of June 15, 2017, the yields between the 10-year and 30-year treasuries have been narrowing, i.e. 10-year is now 2.16% and 30-year is now only 2.78%. See the government website below:
When the yield becomes negative or inverted, market sentiment suggests that the long-term outlook is poor and the yields offered by long-term fixed income will continue to fall. It also spells trouble for the financial sector as what started happening in late 2006. The incentive for depositors to leave their money with the bank for longer periods of time, say 5 to 10 years is to earn a higher interest rate. If the interest rate of return is the same or less for 5 years compared to 1 year, this incentive is gone. This means that profit margins fall for companies that borrow cash at short-term rates and lend at long-term rates, such as hedge funds, banks and mortgage companies. Equity lines of credit and adjustable rate mortgages (ARMs) which are periodically adjusted usually go up since they are based on short-term interest rates. Debtors who got stuck with these loans will need more money to pay for additional interest. They will need to tighten their belts since they will have less money to spend on consumer goods that is why recessions follow an inverted yield curve.
Although we are at record high territories in the stock market, with the Dow trying to breach the new resistance level of 21,700, we live in dangerous times. I see the Dow can quickly lose 3,000 in just a period of 10 to 20 days. The reason for this stock market high is the pro-business stance of this administration even though not very much has come to fruition yet, i.e. the talk about curtailing burdensome regulations, lowering corporate, capital gains and repatriation taxes and increasing the defense and infrastructure budgets. Investors are optimistic that Trump’s government technocrats will continue to develop policies that will increase our GDP which should keep recession farther away in the horizon.