The yield curve — a graph that compares one’s returns on long- and short-term investments — has inverted again. It is one of the main signals for the direction of the economy.
In a typical, healthy market, the yield curve shows lower returns on short-term investments and higher yields on long-term investments; investors typically expect more for their money if they commit to tying it up for a longer period of time. For example, if you were to commit to a 10-year bank CD, you’d expect more of a return than if you only committed to a 12-month CD.
But now, the yield curve has inverted. This means investor demand for long-term investments has risen, and they’ve bid down the returns. In contrast, yields (i.e., your returns) on short-term investments have risen because promoters have had to offer increased yields to pull investors in. Simply put: Short-term yields have risen above long-term yields. This often signals investors are pessimistic about the economy in the short term. They are bracing for negative news.
The yield curve primarily evidences investors’ sentiment on the economy and its outlook.
I’ve lived and invested through several yield curve inversions. I’ve observed that not all businesses or individual investors have a clear idea of what an inverted curve could mean.
In business, for example, an inverted yield curve could signal that sales might slow and share prices might drop. Commercial credit could also tighten, or at least become more expensive. As a result, this would impact spending, leasing and hiring decisions, as well as corporate investments. For independent professionals such as doctors or other business owners, it throws up a warning to evaluate personal investments.
This is because an inverted yield curve is typically known to forecast a recession. According to JP Morgan, inverted yield curves have often been precursors to recessions. For example, inverted yield curves happened just before the 2008 recession and the dot-com bust. I believe it is also worth pointing out that the Federal Reserve projected no interest rate hikes this year, which is not a move to be taken lightly. In my experience, this can signal concern of a weakening economy because it’s a direct monetary policy move intended to prevent any further cooling of money markets, lending and deflation.
Not everyone agrees this is bad news. One Citi strategist pointed out that although inverted yield curves can be a useful early warning signal for oncoming bear markets, they are not a reason to be “outright bearish.” Others say investors might be “overly anxious” after seeing the yield curve invert.
Still, given the data and my personal experience investing during the 2008 recession and dot-com bubble, I believe it’s best to be ready, just in case.
There are a few ways to prepare your business for a potential change in the market.
As a business owner, this might not be the ideal time to sign new long-term leases. There could be discounts on office space coming if the economy does soften, but it might not be an attractive or easy time to take on new debt. Instead, I advise clients to raise more capital than needed to help them maintain a strong cash position so they can take advantage of coming opportunities and avoid cash flow shortages. In other words, stay lean by keeping the following in mind:
• Consider remote freelance help versus in-house hires on fixed salaries.
• If you aren’t already, try to get profitable fast to ensure there is enough profit margin to handle a contraction.
• If absolutely necessary, consider making any needed layoffs sooner rather than later to help you avoid crushing morale with ongoing cuts.
• Check your spending, and cut what is no longer necessary. For example, are there services that you don’t use anymore that are hitting your credit cards every month?
• Trim personal expenses in case you need to take a pay cut to help your business.
If you operate a small business, growth doesn’t have to stop.
Staying lean is key if you’re preparing for a change in the market, but that doesn’t mean you can’t continue developing your small business. For example, you might find that learning how to master online reviews or researching growth tips could benefit your brand. Here are five more ways you can help your business grow if the market sees change:
• Automate mundane daily tasks so you can work on higher-level strategic plays.
• Look for innovative technological tools that could help things operate more efficiently.
• Search for opportunities to buy competitors at discounts and “roll up” your space
• Save part of your marketing budget in case there are discounts on advertising in the future.
• Leverage more user-generated content for search engine optimization and engagement.
Although I’ve found that many investors and business owners tend to shy away from complex investment terms, the yield curve is something to pay attention to. As some have pointed out, an inverted curve doesn’t guarantee a recession and might not be as ominous as it has been in the past, but I believe it’s still crucial to have a plan for your company just in case. And if you prepare accordingly, I believe you can still find success no matter the direction of the market.