Hello, everybody. It's Sam from Financial Samurai, and it is August 14, 2019. And just wanted to talk about the inverted yield curve, which we are now experiencing. The 10-year bond yield is now lower than the 2-year bond yield, and that means an official inversion. And the 10-year bond yield has been below the 3-month bond yield and the 1-month bond yield for a while now, which could also mean inversion, but the classic definition of inversion is the 10-year below the 2-year.

But at any rate, the yield curve has been flat inverted for a year, year and a half now. And it's also interesting to note that if you look at history, whenever the yield curve, the official definition of the yield curve inverts, 10-year and 2-year, a recession comes in 6 to 18 months.

So if you've been wondering what's going on with the housing market, where volume is low and prices aren't rocketing higher, it might be because a lot of consumers are thinking this is it. 2018 was a scare when median property prices fell up to like 10 plus percent in many markets from the first quarter 2018 to the end of 2018.

And people are just wondering, hmm, maybe we shouldn't be buying right now. And maybe there is pent up demand actually as well, because rates, mortgage rates are down at least 1%, if not more like 1.25% from 2018. And that should increase buying power and increase demand for property. But we're not seeing that just yet because I think people are just taking a wait and see approach.

Because again, fourth quarter 2018 was pretty, pretty bad. The market sold off like 15 plus percent. So I just wanted to talk about the inversion again, because we talked about this before and it's good to get an idea of what's going on. So the way to understand the yield curve is to look at it from different perspectives.

So from the lender's perspective, due to inflation, the value of a dollar tomorrow is worth less than the value of a dollar today. So therefore, in order to profitably lend money, you must charge an interest rate. The longer the lending term, the higher the interest you should charge, hence the upward slope of the yield curve.

If the borrower has poor credit score, runs an unstable business, has large job gaps in his or her resume, doesn't read Financial Samurai or listen to Financial Samurai, you're going to have to charge a higher rate. And it's pretty logical. So if you are a bank, your main source of funding is from savings deposits.

For the privilege of holding such deposits, you pay customers an interest rate and hope to lend out their deposits at a higher interest rate for a positive net interest margin. This is the classic way banks do business. It's been going on for a century plus, and that's how the yield curve is upward sloping.

So from a borrower's perspective, it's a little bit opposite here. A rational borrower is incentivized to borrow as much money as possible for as long of a period as possible at the lowest interest rate possible to hopefully get rich. The more you borrow, the more you will likely invest.

And when the borrowing rate is equal to or below the inflation rate, a borrower is essentially getting a free loan. So the classic borrower example is the homebuyer. After putting about 20% down on average, the buyer borrows the remaining 80%. The lower the interest rate, the more inclined the borrower is to take on more debt to buy a bigger, fancier house.

So for people looking to buy property right now, it's a good time to look. Although down cycles in the property market can last 3-5 years on average, looking now when inventory is higher and rates are lower is a much better time than looking last year. So when homebuyers want to stretch, they take out an adjustable rate mortgage with lower interest rates versus 30 year fixed and so forth.

In addition to homebuyers, there are companies large and small that borrow money to grow their respective businesses. If interest rates are lower at every duration, businesses will tend to borrow more, invest more, hire more, and consequently boost GDP growth. So the equation for GDP equals consumer spending plus investment plus government spending plus net exports.

That's GDP growth. And then from the investor's perspective, given the motivations of the borrower and the lender, the investor sees the yield curve as an economic indicator. The steeper the yield curve up to a point, the healthier the economy. The flatter the yield curve, the more cause for concern given the borrower's doubt about the near future.

So right now, you are seeing the 10 year bond yield at about 1.6%, whereas the 2 year bond yield is about 1.65%, and the 1 month bond yield is about 2.15%. So it's pretty inverted right now. So with such an inverted yield curve, if you're the bank, you're disinclined to lend money over a long duration because the return is too low relative to the short end.

You are paying higher deposit rates, so you're getting squeezed there because it costs more, and then you're getting less in profits because you're lending for a long term at a lower rate. So what happens? You just stop lending as much, and you also tighten lending standards. And from the borrower's perspective, you're just hoarding cash because the future doesn't look very bright.

It's very uncertain. But the short term, you're getting 2.1% to 2.3% interest rate on your cash. It's risk-free up to $250,000 for the FDIC. And so the logical conclusion is that you hoard cash, and you wait. You don't invest in the future. And what happens? What happens? Well, the velocity of money that turns and turns around in the economy slows down.

And when that slows down, economic growth slows down. And that is why we've seen historically whenever the yield curve inverts, a recession is 6 to 18 months away. And if you look at history, just look at history, look at the post, look at some charts, 1989, '88, the yield curve inverted.

A recession came in 1991. If you look at 1999, the yield curve inverted. A recession came in 2000. If you look at 2007, the yield curve inverted. There was a recession, big one, obviously, in 2008, 2009. So I really don't think this time is different. Investing is rational long term.

Investors take action to enrich themselves while doing their best to avoid actions that will make them poor. If I want six-pack abs, I'm going to drink water every day and only eat celery and do 1,000 sit-ups, and then I'm rationally going to get six-pack abs and kind of not feel so good because I'm starving.

And everything else long term is very rational. Short term, kind of irrational, right? Like when the Fed raised rates in December 2018 when the yield curve was already flat, it's just dumb. And so they reversed course, right, seven and a half months later. But they're just dumb. There's like short-term irrational noise, everything.

But long term, you've got to think rationally. And so on your road to financial independence, your goal is to not lose massive money because not only does losing massive money hurt. It takes away time and time becomes more and more valuable. Again, if you lose 50% of your money, you've got to get 100% return just to get to even.

And worse is that it probably will take you several years of work and saving and investing to get back to even. And you don't want that. You just don't want that. So everybody right now needs to take advantage of short-term rates. You're getting 2% to 2.5%. Some banks are subsidizing the consumer by paying higher rates to get more deposits.

But most banks are not. They're going to cut rates now because the Fed has started cutting rates. So you get it. Hoard cash. You have got to refinance your mortgage. You want to refinance into the sweet spot of the yield curve. So we're talking seven-year and 10-year arms. That is the sweet spot where you get the most bang for your buck.

That's good duration. The average homeowner only owns his or her home for about eight to nine years. So if you're refinancing seven- to 10-year fix, that is pretty sweet. And you probably also want to look at real estate. Real estate right now is a little bit soft because inventory is piling up in a lot of these big cities.

It's a boom-bust cycle. But you don't have to pay the market rate right now. You should look. You should see what's out there. And you should lowball, especially stale fish listings where the broker just simply missed price and it's been on the market for months, maybe years. That to me is pretty interesting.

And especially since you're going to save about one to one and a quarter percent on your mortgage if you've got to take a mortgage, that's pretty rational to me. So I hope everybody is paying attention. If you've got a day job, be nice to your boss and colleagues because during recessions, people who are not nice are also the first ones to go.

Thanks, everyone. Stay safe out there. And if you like this podcast, please leave a positive review.