“You don’t need a weatherman to know which way the wind blows,” Bob Dylan once famously sang. It may have been solid meteorological advice, but not a very prudent financial strategy.
Today’s economic forecasters — financial advisors, economists and other analysts — use a variety of tools to gauge the climate for business and markets. Some key barometers have a better track record than others.
For example, in Canada and the U.S., the “yield curve” has proven adept at signaling the onset of recessions and recoveries. When yields on short-term government bonds exceed long-term yields, an economic slowdown usually results. Such a yield “inversion” happened in late 2005 — one of the first signs that a recession would begin in December of 2007.
For the individual investor, understanding the yield curve and other predictive resources is useful not for making personal judgments about the economic climate, but rather for helping to clarify what may be driving the decisions of institutional investors, businesses and policy makers. Your own personal circumstances, risk tolerance and time horizon should remain your key decision-making variables.
In normal economic circumstances, the yield curve on 10-year Government of Canada bonds is typically 1.4 percentage points higher than the yield on 3-month bills. When the spread “inverts,” short-term bonds pay more than long-term bonds. This is a sign that many investors believe the economy will soon stall, and that central banks will need to lower interest rates to jump-start economic activity.
The yield curve in Canada as well as the U.S. is strongly influenced by the actions of the Federal Reserve in Washington. Because of that, it is no surprise that analysts seeking to spot trends pore over the minutes of the periodic Open Market Committee meetings, where the Fed chairman and governors set monetary policy.
At times the analysis almost takes on the character of Kremlinology, as observers look for clues to such questions as: When and how will interest rates change? What do the members believe about the strength of the economy? Should governments pump more liquidity into the economy, such as buying up additional bonds?
To anticipate such moves, analysts also keep a close watch on the Wall Street Journal Economic Forecasting Survey. It’s a monthly poll of more than 50 economists who make predictions on major economic indicators, such as inflation, interest rates, taxes and growth. The aggregate forecasts carry a great deal of credibility.
The more closely all such forecasts are examined, the more obvious it becomes that any consensus can shift quickly and completely misjudge emerging trends. Even the vaunted yield curve is not infallible. Yield curve inversions have signaled recessions that never happened. In these cases, economic fundamentals were still strong; only the interest rate ratios of government bonds were volatile.
Of course, not all financial prognosticators will admit that such a key forecasting tool as the yield curve can ever be wrong. Like devotees closely scrutinizing every quatrain of Nostradamus, the prediction was crystal clear, they will say — it was the interpretation that was off the mark.
Important information about mutual funds is found in the Fund Facts document. Please read this carefully before investing. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Unit values and investment returns will fluctuate.
Insurance products, including segregated fund policies, are offered through Beyond Business Financial Solutions Inc., and Investment Representative Nathan Garries offers mutual funds and referral arrangements through Quadrus Investment Services Ltd.