4. Corporate 10-Year’s Widen Against 10-Year Treasuries. My model looks at spreads in six month intervals. Six months earlier, the Composite Corporate Bond Rate (CCBR) was at 4.32% and the 10-year Treasury was a 2.4%. Today, the spread is identical, with the CCBR at 3.87% and the 10-year treasury at 1.95%. (That’s 20 more for the “no-recession” folks.)
5. 3-Month Treasury Versus 10-Year Treasury. History suggests that one should be compensated by 2.5% or more for when taking the risk of investing in the longer-term 10-year Treasury note over a 3-month Treasury. If the spread is less than 2.5%, the risk of recession rises (a la flattening of the yield curve). Today’s 3-month offers 0.2%, while today’s 10-year offers about 1.95%… a difference of only 1.93%. That’s 20 percentage points for the recession gloom.
So what does the scoreboard say? It places the odds at 50-50. There’s a 50% chance that we will experience a recession in 2015 and 50% chance that we will avoid it.
The manufacturing slowdown, the rapid deceleration of expectations by consumers and the flattening of the yield curve are troubling. In contrast, the actual manufacturing data point, the U.S.stock market trends and the stable spread between corporate bonds and comparable treasuries are reassuring.
Is there anything an investor should be doing differently, then? That depends. If you’ve been relying too heavily on stock price appreciation, you’d be wise to ratchet back on extreme aggressiveness. Perhaps shift a portion of your stock allocation to foreign stock “faves” such as iShares Currency Hedged Germany (HEWG) or iShares Europe Minimum Volatility (EFAV). Similarly, a 70 stock/30 non-stock might want to take the growth down to 60%, 55% or 50%, simultaneously adding to non-stock assets.
More importantly, if you’ve misjudged the benefits of non-stock assets, you may want to raise your allocation to the assets best suited for the possibility of a recession-based stock bear. One might look at the uptrend in longer-term U.S. Treasuries via funds like iShares 10-20 Year Treasury (TLH). One might even be intrigued by currency proxies like WisdomTree Dollar Bullish (USDU) or even AdvisorShares Gartman Gold/Euro ETF (GEUR).
To be frank, a 50% recession possibility is worrisome. Granted, the Fed could step in with more stimulus before the year is out, though it may be difficult to do after all the hype about its plans to raise its target rate several times in 2015. Similarly, the U.S. economy may prove more robust than I believe it is, where the yield curve steepens rather than continues to flatten.
Nevertheless, the prudent approach combines non-stock assets that are trending higher – TLH, USDU, GEUR – with stock assets that are trending higher. In the same vein, one can apply a multi-asset stock hedge approach in an environment where asset volatility and economic uncertainty are elevated. My approach to multi-asset stock hedging? Tracking the FTSE Custom Multi-Asset Stock Hedge Index (MASH) offers an unleveraged alternative to conventional methods such as shorting, using inverse ETFs, going to cash or using put options in margin accounts.