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The Inverted Yield Curve: Is There A Signal In The Noise?

Economist Aswath Damodaran ponders the question in this short presentation.
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The Acquirer’s Multiple® is the value metric financial acquirers use to find takeover targets. Deeply undervalued stocks are good to own because they can be taken over, creating a quick win, or simply revert back to value over time. As the #1 New Release in Amazon Business and Finance The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market describes, portfolios of stocks with a low rank based on The Acquirer’s Multiple® offer market-beating returns over time. Tobias Carlisle is the founder of The Acquirer’s Multiple®. He is the founder of Carbon Beach Asset Management LLC. He is best known as the author of the #1 new release in Amazon’s Business and Finance The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market, the Amazon best-sellers Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014), Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012) and Concentrated Investing: Strategies of the World’s Greatest Concentrated Value Investors (2016). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Johnny Hopkins is a financial analyst who specialises in deep value stocks at The Acquirer’s Multiple®. The Acquirer’s Multiple® is a stock screening website based on the investment strategy described in the book The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market, written by Tobias Carlisle.

Here’s a short presentation by Aswath Damodaran on the recent inverted yield curve and whether there is a signal in the noise. He writes:

On December 4, 2018, the yield on a 5-year US treasury dropped below the yields on the 2-year and 3-year treasuries, causing a portion of the US treasury yield curve to invert.

Since inverted yield curves have predicted recessions almost perfectly for the last six decades in the US, it was viewed as a big reason for the market’s drop that day. In this session, I start with the impressive track record that inverted yield curves have had as recession predictors, posit that this may be because they are stand-ins for the “Fed” effect (on the economy) and then look at the data over the last 56 years.

I find that it is the short end (2 yr vs 1 yr), not the more common used long end (10 yr vs 2 yer), of the yield curve that offers predictive power, and even that power is limited. I also find that the post-2008 data yields very different results than the pre-2008 data, suggesting that the crisis may have reduced investor faith in the powers of the Fed and consequently altered any predictive power that the yield curve may have had prior to the crisis.

You can watch the short presentation here:

(Source: YouTube)

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The astronomer Carl Sagan said, “It was easy to predict mass car ownership but hard to predict Walmart.”