On Aug 14, Wall Street collapsed following main treasury yield curve inversion. The yield between 2-year U.S. Treasury Note and 10-year U.S. Treasury Note inverted, which is considered as a powerful signal of an impending recession from the bond market. Investors, who were already concerned about lingering U.S.-China trade conflict and slowing growth rate of the U.S. economy, rushed toward safe-haven sovereign bonds, resulting in a stock market rout.
The blue-chip Dow 30 Index plunged 800.49 points or 3.05%, reflecting the biggest single-day loss since Dec 4, 2018. The market benchmark S&P 500 Index and tech-heavy Nasdaq Composite plummeted 2.93% and 3.02%, respectively. Both indexes posted their worst single-day performance in 2019 so far.
Inversion of U.S. Treasury Yield Curve
On Aug 14, yield on 10-year Note dropped to 1.623%, which fell below the 2-year Note’s yield of 1.634. Moreover, the yield on short-term 3-month Treasury Bill stayed at 1.997%, which is higher than both 2-year and 10-year Notes. Meanwhile, yield on long-term 30-year U.S. Treasury Note plunged its all-time low level to 2.061%.
The yield curve (which measures interest at any given point of time for bonds of same quality but different maturity dates) of government bonds are generally upward sloping, implying that a higher rate of interest is needed for individuals to hold longer maturity bonds. However, an inverted yield curve is generally characterized as market’s diminishing expectations about future economic growth.
In fact, several economists consider inversion between the 2-year and 10-year bond yields as a clear indication of an upcoming recession. Moreover, inversion between 3-month and 10-year bond yield is continuing since March 2019. CNBC stated that since 1978, there were five yield inversions between 2-year and 10-year Notes, all of which lead to a recession.
Globally Weak Economic Data
The U.S. economy is expanding for the 11th year. However, the manufacturing sector and business investment took a major hit owing to a prolonged tariff battle with China. Chinese industrial output in July fell to 4.8%, its lowest level since 2002. Retail sales of the world’s second-largest economy dropped to 7.6% in July compared with 9.8% in June.
Germany, the fourth-largest economy in the world, witnessed a 0.1% contraction in its second-quarter 2019 GDP, the first time since the third quarter of 2018. Industrial output in July also declined 5% year over year.
The GDP off the Eurozone economy as a whole declined to 0.2% in the second quarter compared with 0.4% in the first quarter. Meanwhile, second-quarter 2019 GDP of the U.K. contracted 0.2%, for the first time since late 2012. The manufacturing sector declined 2.3% in the second quarter, marking its biggest quarterly fall since the first quarter of 2009.
Notably, at the end of 2018, around $8 trillion was invested in bonds with negative returns. However, this figure has increased substantially to $15 trillion so far in 2019. This clearly indicates worldwide recessionary fears among market participants.
Possibility of a Recession But Not Immediately
The bond market feature of Treasury yield curve inversion is no doubt sending a recessionary signal in the U.S. economy. However, an immediate recession is uncalled for. As per a survey by Credit Suisse, historically, recession came after 22-months on average after the yield curve inversion.
In fact, the S&P 500 provided an average of 15% return for 18 months after the 2-year and 10-year bond yield inversion. The last time that a 2-year and 10-year bond yield inversion happened was in December 2005 but recession hit the U.S. economy after two years.
Moreover, treasury yield inversion does not simply mean a recession. The yield curve needs to stay inverted for quite some time. Meanwhile, the Fed can play a role with an aggressive dovish stance by cutting rate in September again after July to boost the aggregate demand and investment of the economy. The CME FedWatch has assigned 100% probability for a 25 basis-point cut and 23.5% probability of a 50 basis point cut of benchmark interest rate in September.
Our Top Picks
At this juncture, we have applied five criterions to select five stocks to protect one’s portfolio. First, assuming the market will remain extremely volatile, low beta (beta value less than 1 but greater than zero) stocks will be less volatile than the broader market. Second, stocks are providing regular dividend ensuring a steady income stream. Third, all five stocks are currently priced below $15, making them affordable to general investors.
Fourth, all five stocks have high growth potential for the rest of the year and finally, each of these five stocks carries a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
The chart below shows price performance of our five picks year to date.
Exantas Capital Corp. XAN is a real estate investment trust that primarily focuses on the origination, holding and management of commercial mortgage loans and commercial real estate-related debt investments in the United States.
The company has expected earnings growth of 60.6% for the current year. The Zacks Consensus Estimate for the current year has improved by 6.5% over the last 30 days. The stock has a dividend yield of 7.94% and beta of 0.75.
Alamos Gold Inc. AGI engages in the acquisition, exploration, development and extraction of gold deposits in North America. It also explores for silver and other precious metals.
The company has expected earnings growth of 280% for the current year. The Zacks Consensus Estimate for the current year has improved by 26.3% over the last 30 days. The stock has a dividend yield of 0.57% and beta of 0.30.
TiVo Corp. provides media and entertainment products for the consumer entertainment industry worldwide. It operates in two segments, Product and Intellectual Property Licensing.
The company has expected earnings growth of 10.7% for the current year. The Zacks Consensus Estimate for the current year has improved by 12.2% over the last 30 days. The stock has a dividend yield of 4.27% and beta of 0.20.
Donegal Group Inc. DGICA is an insurance holding company, which provides personal and commercial lines of property and casualty insurance to businesses and individuals in the Mid-Atlantic, Midwestern, New England and southern states.
The company has expected earnings growth of 180% for the current year. The Zacks Consensus Estimate for the current year has improved by 14.3% over the last 30 days. The stock has a dividend yield of 3.94% and beta of 0.29.
North American Construction Group Ltd. NOA provides heavy construction and mining services primarily in Canada. It offers services to large oil, natural gas and resource companies.
The company has expected earnings growth of 228.6% for the current year. The Zacks Consensus Estimate for the current year has improved by 29% over the last 30 days. The stock has a dividend yield of 0.50% and beta of 0.54.
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