Just a few months ago, a plethora of so-called pundits were ringing the alarm over the inverted yield curve: an economic indicator that supposedly signals that a recession is on the horizon.
Plenty of investors hit the panic button and sold out of their stock positions, only to miss out on a tremendous rally back towards all-time highs. And if you acted based on popular opinion at the time, with those hard-to-avoid alarmist pieces that urged you to make rash decisions, like selling all your stocks in response to the yield curve’s inversion, you took a hit to the chin. You followed the herd, and you got burned for doing so.
While it is a good idea to mitigate risk by owning all-weather securities that’ll help buoy your portfolio in down markets, it’s never a good idea to play just one side of the coin based on what you’ve heard or what you want to believe. When it comes to investing, confirmation bias is a dangerous thing, and if you’re either going all-in on a bullish or bearish stance, you will find what you’re looking for to enforce your position.
Back in August, when the yield curve inverted, causing the Dow to plunge 3% in a day, I noted that the yield curve many media outlets were looking at (the 10-year/two-year spread) was the wrong yield curve to observe.
And even if investors were worrying about the correct yield curve (the five-year/three-month spread) that there was no real danger, since the inversion of such a yield curve would also require it to remain inverted for a full quarter, which I thought was “unlikely” given “the Fed could just step in and prevent the ‘ticking time bomb’ from triggering in the first place.”
As it turned out, Fed chairman Jerome Powell made a mistake by raising rates in the first place, and he’s been cutting to make up for it. Indeed, there are times where there’s nothing to fear but fear itself.
Taking market sell-offs over “nothing” to the bank
In a prior piece, I’d urged investors to avoid following the herd out of stocks over the inversion of the 10-year/two-year spread and to take a contrarian stance by being a buyer of beaten-up stocks like Toronto-Dominion Bank (TSX:TD)(NYSE:TD) as they went on sale over yield curve stupidity that I thought should have been immaterial.
While the Canadian banking scene remains sluggish, with short-sellers that are still bearish on the broader industry, TD Bank has continued to remain resilient in spite of less-favourable macro conditions. Just because there are headwinds in the sector doesn’t mean that a catastrophic implosion is on the horizon.
Unfortunately, anything short of doom and gloom doesn’t make for a very good story.
The Canadian banks are more robust than most would give them credit for, and TD Bank arguably has the best loan book and the least-volatile earnings stream (thanks to its retail banking business) to navigate through a recession and come roaring out of the gate when headwinds finally fade away.
Of course, to get the most upside out of TD Bank’s inevitable rebound along with the broader banking scene, you’re going to be contrarian, and that means buying the on a market-wide panic and before all the sell-side analysts have a chance to change their “holds” to “buys.”
Today, TD Bank stock is up nearly 7% from when I recommended it back in August, and while shares have been dragged lower by the recent brokerage wars, I think the 3.9%-yielding stock still offers tremendous value for long-term thinkers moving into 2020.
Foolish takeaway
It’s tough to take a page out of Warren Buffett’s playbook by being greedy while others are fearful, especially if you lack a full understanding of economic indicators.
Fortunately, you don’t need to be an economist to do well in the stock market, because not even Buffett himself invests based on how he thinks the economy is going to fair in the near term.
Any time the market goes into a panic over stupidity, do some buying, and you’ll profit off those beginners who rush to the exits just because everybody else is.
Stay hungry. Stay Foolish.
