“This Time It’s Different”

“This time it’s different” is one of the most dangerous phrases in the investment world.

Economies and markets have always gone through cycles of boom and bust. And each time, experts will use this phrase (popularized in 2009 when Rogoff and Reinhart used it as the title for their widely-celebrated book about the cycles of debt and default/crisis), to explain away the advance warning signals, claiming that circumstances have changed and that the old signals no longer work.

A few weeks ago, the US yield curve inverted – i.e. long rates moved lower than short ones. Specifically, yields on long-dated 10-year US treasury bonds were lower than those on short-dated 3-month T-bills (since then, the curve reversed the move and became slightly positively-sloping again). Historically, the shape of the yield curve has been one of the most reliable indicators of future growth. An inverted curve has been a good predictor of economic recessions. In fact, yield curve inversions preceded each of the last seven US recessions. In the previous cycle, for example, the curve inverted in August 2006, a bit more than year before the recession started in December 2007. There have been two notable false positives: an inversion in late 1966 and a very flat curve in late 1998.

The Federal Reserve Banks of Cleveland and New York maintain econometric models that link between the shape of the yield curve and future growth (see here: https://www.clevelandfed.org/our-research/indicators-and-data/yield-curve-and-gdp-growth.aspx and https://www.newyorkfed.org/research/capital_markets/ycfaq.html ). They have both been recently indicating that the risk of a US recession within the next 12 months is clearly on the rise and is currently (with the 3m-10y curve just barely positive) estimated to be around 30% (the probability slightly differs between the two models) -- very high in an historical context

Since the inversion event, I have seen many commentators and reports explaining why investors should not worry -- because this time it’s different. Some of the explanations even seem plausible. And maybe it will be different this time around. However, if we do get a sustained inversion in the yield curve, would it be wise to bet against an indicator with such a strong track-record? Alternatively, at this important juncture, would it not be wiser to remind ourselves of a different adage, usually attributed to Mark Twain: “history does not repeat itself, but it does rhyme”?