The narrowing gap between short- and long-term Treasury yields seems to be unnerving Wall Street. One reason is a somewhat mythical theory that a smaller spread between long- and short-term interest rates, i.e., a flatter yield curve, foreshadows an economic slowdown.
If you look back to the 1990s, however, the data shows unequivocally that the economy can flourish for long periods despite a relatively flat yield curve.
Beginning in July 1995, the Federal Reserve reduced interest rates by 75 basis points. (One percentage point equals 100 basis points.) The spread between long- and short-term rates averaged just 35 basis points from 1995 through 1999, down from 140 basis points in the first half of the decade. Today, the spread is about 50 basis points.
Selling or avoiding equities during the late 1990s, thinking that the yield curve was predicting weak growth, was a losing proposition. Both the economy and the stock market surged, with gross domestic product expanding by an average of 4.5 percent each quarter and the S&P 500 index up 139 percent.
So to bet against the economy and the financial markets due to a flattening yield curve is a dangerous game. A relatively flat yield curve is most likely consistent with a period of economic stability, as actual and expected interest rates hew toward neutral longer-run rates, which currently are deemed to be lower now than in the past. In other words, a combination of upward-trending economic growth, stable inflation and low unemployment is a Goldilocks-like economy.
Furthermore, academic studies have shown that patient, long-term investing continues to be one of the most successful investment strategies. A corollary might be that volatility begets selective bargain-hunting among the resultant debris.
If you are unable to find fault with your portfolio, do not be ashamed to stay the course. Unfortunately, I cannot take sole credit for those timely words of wisdom.
“I’ve always believed that investors should ignore the ups and downs of the market.” wrote Peter Lynch, the former manager of the Fidelity Magellan fund, in his 1989 book, “One Up on Wall Street.”
Periodic declines in the stock market are inevitable. It is impossible to predict exactly when corrections will occur, how long they will last, or their degree of severity. And, yes, they do occur for reasons other than a flattening yield curve. That is when fortitude will see you through the day.
It would be a rare occasion indeed in which liquidation would be the strategy of choice. Of course, it is always judicious to be prepared.
Be cognizant of your investment objectives. Opportunities abound in bull markets, bear markets and everything in between. Therefore, if you own shares in a fundamentally sound company that has become a victim of a panicked market's "herd instinct," give some consideration to adding to your position.
In any period of confusion and carnage, the intrinsic value of securities often increases as the shares go on sale. And dividends continue to be an excellent proxy for intrinsic value. Look for under-valued dividend achievers. A dividend achiever is any company that has increased its payment of cash dividends annually for at least 10 years.
What about trying to predict a major market upswing or downswing? On Wall Street, being glib often equates to survival. Do not be swayed by soothsayers who forecast short-term market moves.
Trying to time the market can be deadly to a portfolio. Instead, concentrate your efforts on careful fundamental analysis. Select only those investments whose true worth is not reflected in their share price. Do so by focusing your efforts on areas dismissed by others.
Being leery of owning out-of-favor stocks is both wrong and unprofitable. Quite often the risk of adverse developments is already reflected in the share price. Furthermore, future positive developments often result in broader analytical support and increased institutional interest. And this new-found popularity frequently means higher share prices.
Lauren Rudd is president of Rudd International, an asset management firm. Neither Lauren Rudd nor his employees hold any shares discussed or have plans to buy them within 30 days, nor is there any intended inducement to buy or sell any security. You can write to Lauren Rudd at Lauren.Rudd@RuddInternational.com or call him at 941-706-3449. For back columns, go to www.ruddreport.com. Lauren Rudd offers commentary Thursdays on SNN News 6 during the 5:30 p.m. live newscast.