Back in July I printed an article talking about the global yield curve inversion which indicated the world was moving into a global recession. However, while the trend of the US 10Y-2Y spread on treasuries has been heading toward an inversion for some time, it hadn’t occurred yet.
Today; however, we had our first US yield curve inversion in the 5Y-3Y spread.
I believe this caused the computers that run much of the automated trading in the markets to start a sell-off which resulted in the major indices falling about 3% in a single day.
Source: Yahoo Finance
While the mid-term treasury rates in the 5Y-3Y inverted, the 10Y-2Y rate spread that has preceded 7 of the last 8 recessions has not quite inverted yet. We still have a slight 0.21% difference between the two as I write this article.
Source: Guru Focus
I can only imagine what the computers will do with the markets when that yield curve finally inverts and how much of a sell-off we will get. The SEC’s circuit breakers are designed to kick in at 7%, 13%, and 20% sell-offs which may prevent the computers from a truly brutal one day sell-off.
However, much of what goes into algorithmic trading is unknown. At a basic level, the systems sell when markets are down and buy when they are up. But they are much more complicated than that. The major effect is that sell-offs and recoveries seem to happen in faster cycles that humans may not be used to. We will just have to see what happens when that fateful day when the yields between the 10Y and 2Y cross.
Further complicating matters were banking stocks which took a strong beating on the day and indications that the banking sector is now bearish in 2018.
Source: CNBC and FactSet
Further, banks have not done well so far in 2018. The SPDR® S&P® Regional Banking ETF is down over 7% YTD.
Source: State Street Global Advisors
The question is really whether the positive retail prints during the holiday season will hold up the markets or the debt issues will continue to drag down the banking sector and also cause more sell-offs in the market. I recap today’s action and discuss some strategies for dealing with the increasing market risk in your portfolios in the following video.