Protect Your Portfolio From An Inverted Yield Curve

In March, the spread between the 5-year Treasury bonds and the 30-year notes inverted. This means that the yield on the shorter-term bonds was actually higher than the yield for the longer-term notes. This is a signal to some that a recession is coming.

Since 1955, equities have peaked six times after the start of an inversion, and the economy has fallen into recession within seven to 24 months from the time it first occurred. This inversion occurred in 2019, and then we did drop into a recession at the start of the Covid-19 pandemic. The inversion also happened in 2006, prior to the start of the financial crisis, which began in 2007. Those are the most recent occurrences, but there are others.

Not all the times we have seen the yield curve invert have we experienced a recession. Furthermore, from a historical view, a recession occurs every few years anyway, so the idea that the inverted yield curve is the cause or the canary may be a little overplayed.

However, we know the Federal Reserve is raising rates and will likely begin reducing its balance sheet. We know that we are currently in a high inflationary period. We know that we still have supply chain issues around the world. We also have a lingering world power problem called Russia, whom we honestly have no idea what they may try to do next, and this obviously raises uncertainty throughout the markets. And, believe it or not, the Covid-19 pandemic is not yet over. The market and economy have a lot of different headwinds that need to be navigated in order to avoid a recession. This is not to say that a recession is guaranteed, but it’s not too much of a stretch to say that one may be coming.

So, if a recession is coming, where would you want some of your money?

Most market participants agree that prior to and or during a recession, having money parked in quality companies that produce strong cash flow and have healthy balance sheets is the best place. It’s also not a bad idea to invest in companies that have weathered the ‘recession’ storm in the past and came out the other side in good standing. And when I think of those types of companies, I instantly think of stocks like the dividend aristocrats.

The Dividend Aristocrats are a group of stocks that have not only paid a dividend for 25 consecutive years but increased their dividends for at least 25 consecutive years, many of which have done so a lot longer. This ability to not only pay but raise their dividend every year for that many years typically shows stability, longevity, and a business that is operating on solid ground. However, not all businesses that meet all these requirements will weather every storm for decades to come; some may see their industries wash away over the next 30 years, like, for example, the oil and gas industries, as renewable energies become more dominant. So, even though these are very strong companies, investors can and should take one more step to protect themselves, which is buying these dividend aristocrats through ETFs, not individual stocks. This way, the ETF protects you against single stock failure.

A few of the top dividend aristocrat ETFs are; the ProShares S&P 500 Dividend Aristocrats ETF (NOBL), the SPDR S&P Dividend ETF (SDY), and the ProShares S&P MidCap 400 Dividend Aristocrats (REGL). NOBL owns stocks that are the true aristocrats, those who had paid and increased their dividends for 25 years. SDY owns stocks that have paid and increased their dividends for at least 20 years, while REGL goes a little further and owns stock in companies that have increased their dividend for at least 15 years, but only in the mid-cap market.

This all increases or decreases the diversity of the ETF, which is evident when you look at each fund’s holdings. NOBL has 64, while SDY has 119, but REGL only has 49 holdings despite having the dividend increase bar the lowest timeframe; it only invests in those mid-cap companies.

Additionally, all three funds pay a decent dividend yield themselves, at 1.95% for NOBL, 2.62% for SDY, and 2.65% for REGL. These yields also give these funds a leg up on other investments during a recession since bonds will likely be falling, and obviously, the high valued-growth stocks will take some big hits if a recession does come around. Furthermore, investors who buy these types of ETFs at times like this, when the next recession is still off a ways but in the far distance, you can avoid being the last one to the party and paying some of the highest prices.

Matt Thalman Contributor - ETFs
Follow me on Twitter @mthalman5513

Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.