Yin and Yang

Dear Reader,

Yin and yang (English: /j?n/, /j??/), also yinyang or yin-yang, is a concept that originated in Chinese philosophy, describing an opposite but interconnected, self-perpetuating cycle. This 'technology' of yin and yang is the foundation of a critical and deductive reasoning for effective differential diagnosis of disease and illnesses within (Taoist influenced) traditional Chinese medicine. But it may also be applied on very different fields, such as the economy (bulls vs bears) or even politics (Donald Trump vs Kamala Harris).

I'll show you an example of how yin can become yang and yang can become yin, depending on the perspective and context.

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It all starts here: the spread between 10-year and 3-month US treasury is widely recognised as a reliable indicator of a recession. This model uses the slope of the ?yield curve, or “term spread,” to calculate the probability of a recession in the United States twelve months ahead.

The FED names this "The Yield Curve as a leading Indicator" and so currently the calculated probability is higher than 50%. Last April it was even touching 70% probability for April 2025.

So basically this means we may expect a recession. An inverted yield curve, which is the situation today, where short-term interest rates are higher than long-term rates, is often seen as well as a predictor of an upcoming recession. This is because it is an indication that investors have less confidence in the long-term economic outlook.

During a recession central banks (like the FED in the US or the ECB in Europe) then will often lower interest rates to stimulate the economy. This is done to encourage consumer/business borrowing and spending, which can help boost economic activity. So if recession comes we can expect also lower interest rates.

Another interesting statistic is the "expensiveness" of a stock market like the S&P 500 index.

Historically the S&P 500 seems pretty expensive today and statistically it even bluntly states this is two to three standard deviations away (i.c. read: overpriced) versus the average over a significant past period of 30-100 years and this on a set of 19 out of 20 metrics.

The Z-score (*not to be confused with the Altman Z-score) column indeed is a measure of a value's relationship to the mean of a group of values. So -IF- the stock market is overpriced this would also signal a cooling economy in the near future, corresponding with our previous finding of the signalling of a recession. Again we may assume that interest rates will fall then.

In general this is actually what the broad market and analists believe and tell us: interest rate has to come down because it is too high now. And the yield curve has to invert again soon.

This is the Yang component: strives for "order" and "the known". Recession: economy down => inflation up => interest rates down. It is the masculine side.

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However there may also be a Yin side to the picture. Have a deep look at this graph below which is over the past 60+ years and shows us the actual US 10 year treasury bond rate.

We see the same periods of recession as in the first pictures, though despite two recessions in 1970 and 1974 (and even a very short one in 1980), the 10 year interest rate went UP to a whopping 15.25%! I really do remember this period vividly, as this was during my youth and my parents had just started their own retail electro business in a very small village located next to the Dutch border in the North of Flanders. Good Belgians as we were, my mom and dad slipped regularly over the border to collect the interest coupons from Rabobank and/or ABN Amro, two Dutch banks who were building a separate business model based on cross- border banking...

The point I'd like to make is that this graph suggests that a cooling economy or a recession does not imply automatically that interest rates will go down. On the contrary they may go up further again pretty quick during and after the recession.

This is the Yin component: it strives for "chaos" and "the unknown". It is the feminine side.

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So depending on what time horizon you have in mind, it looks to me that there is still lots of potential upside possible on interest rate. If this scenario would happen it would be a huge surprise to most investors and certainly to those who invested in bonds with the idea that they would make a gain on "lower interest rates in a near future". It would be a big RESET. The bezzle at its best.

Cheers as always,

Luc