Yield curves are steepening

The slope of the yield curve is one of the most reliable indicators of future nominal growth. Steeper curves forecast faster nominal growth, flatter yield curves forecast slower growth, and inverted yield curves forecast recession.           

Global yield curves are steepening, which supports the forecasts of global leading indicators. Chart 7 shows the percentage of global yield curves that are inverted (i.e., forecasting a recession). In 2008, 41% of global yield curves were inverted. Currently, it is only 2%. The US yield curve, for example, has been steepening for 5 months.

Steepening global yield curves imply that most investors’ asset allocations are inappropriate, and are too defensively positioned. Our research has argued for nearly 30 years investors should emphatically overweight bonds and extend duration when the yield curve inverts. Investors’ enthusiasm for bonds this past summer (i.e., lower for longer) seems quite counter to that research. They myopically looked for income despite rising inflation expectations and a steepening yield curve.

Our positioning

We began to reposition our portfolios for improving global nominal growth beginning in the first quarter of 2016 and, if we are correct regarding the improvement in the global economy, we expect our views to become consensus during 2017.

As of now, our equity portfolios remain overweight cyclical, smaller capitalization, and lower quality stocks along with emerging markets, while remaining underweight non-US developed markets. Because inflation expectations appear to have troughed, short duration remains the primary theme within our fixed-income holdings and we maintain modest weights to gold and gold miners.

The world is changing