| After a couple of years of weak returns for stocks, the bulls are firmly back in control. Recession worries have vanished, and everyone's guzzling the stock market Kool-Aid once again. But here's the thing. While most investors searching for economic clues fixate on the stock market's performance, there's a far more accurate indicator they often overlook: the bond market. You see, the collective wisdom of the bond market (which is significantly larger than the stock market) provides a much more reliable barometer of economic health. And for close to two years now, it's been waving a huge red flag. I'm talking about the inverted yield curve. Marc alluded to this phenomenon in the January Annual Forecast Issue of The Oxford Income Letter, but a lot can change in just a few months. So let's take a fresh look at the yield curve and what it means for us as fixed income investors. In a typical environment, you earn higher interest rates by lending money over longer periods, because the extra interest offsets the added risks. Plotting this simple relationship produces an upward-sloping curve - hence the name "yield curve." However, when short-term rates climb above long-term rates, it causes the curve to "invert." This unusual circumstance has been one of the most precise predictors of recessions, having preceded all seven economic downturns since the late 1960s. We saw the yield curve start to invert in July 2022, and it has remained inverted for a record length of time, beating the previous record of 624 days. Historically, a recession has begun between six and 24 months after the curve has become inverted. At 21 months and counting, we're deep in the danger zone. Sirens should be sounding. Now, I know the rebuttal: Maybe this time is different. After all, the Fed is still projecting a "soft landing," many companies are hiring and the AI boom is underway. In other words, none of this feels like the cusp of a recession - especially compared with how things were a year ago. And of course, I'm not suggesting that you should start panicking or turn completely bearish on the market. Correlation is not causation, and while every recession in recent memory was preceded by an inverted yield curve, a recession has not followed every inversion. But even so, I do believe that investors should take the bond market's warning seriously and position their portfolios accordingly. How, you ask? By investing in high-quality, short-term bonds. There are a few compelling reasons to favor the shorter end of the yield curve today. First and foremost, your payout will be much greater. Thanks to the Fed's aggressive rate hike cycle, short-term Treasury yields are now hovering at nearly 25-year highs of 5% or more. And short-term corporate debt offers equally juicy yields. As inflation cools, the real yields on these offerings will become even more attractive. And if credit conditions deteriorate, these elevated yields can help offset any potential capital losses on your bonds. Secondly, shorter-term bonds are typically the biggest winners when easing cycles begin because they are generally more sensitive to interest rate changes. So let's suppose the inverted yield curve's warning turns out to be correct and a downturn finally hits the economy in the next year. That could still bode well for short-term bondholders, who'd likely see solid price appreciation as a result of the Fed slashing rates. Time to Bolster Your Defenses While investors are obsessing over how many times the Fed might cut rates, they're missing an important message from the bond market: Stay defensive! Fixed income investors have a unique opportunity to position themselves strategically by favoring shorter-term, higher-quality debt securities that offer not only higher yields but also lower maturity risk. It's truly a no-brainer. For those of you looking to increase your exposure to bonds, The Oxford Income Letter is a great place to start. Go here for more details on this publication. Good investing, Anthony Summers | 
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