Stop, Drop, and Roll: The Yield Curve Inversion

In this episode of MarketFoolery, host Mac Greer talks with analyst Bill Mann about the biggest business news. First, they look at the mountain of trouble that Boeing (NYSE: BA) is in, and how the 737 Max disaster will ripple out to the airlines. Then, the pair discuss the dreaded inverted yield curve -- whether or not it really predicts recessions, what it really measures, and how investors should proceed. Also, stay tuned for an enormously impressive fraud perpetrated on tech giants Facebook (NASDAQ: FB) and Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG), some hot takes (from Tesla's (NASDAQ: TSLA) chairman) about Elon Musk's tweeting habit, a quick bull case for airlines, and more.

A full transcript follows the video.

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This video was recorded on March 27, 2019.

Mac Greer: It's Wednesday, March 27th. I'm Mac Greer. Joining me in studio, we have the one, the only Motley Fool analyst, Bill Mann. Bill, how are you doing? It's just you and me.

Bill Mann: It is. I'm doing great, Mac! How are you?

Greer: I'm good! How are you feeling right now? If you had to characterize your mood, would it be cautiously optimistic? Would it be very optimistic? Would it be filled with regret?

Mann: [laughs] Always, always regretful and remorseful, though if we're talking specifically about the markets, I am cautiously optimistic, which I think ultimately is the only place where investors ought to be.

Greer: OK, good. I like that. That's a nice launching-off point because we are going to be talking about the market. We're also going to be talking about why Facebook and Google, paying their bills isn't always such a good thing. We'll get to that. And we'll talk some Tesla tweets.

But we begin with Southwest Airlines (NYSE: LUV). On Tuesday, a Southwest 737 Max made an emergency landing in Orlando due to an engine issue. Now, Bill, only two crew members aboard. No passengers. That's the good news. On Wednesday, Southwest announcing that they're cutting their first-quarter forecast due to, yes, the grounding of their 737 Max fleet. Southwest, the first airline to report an impact on earnings from the 737 Max.

Mann: This is such a hard story. I don't want to make the slightest amount of fun about it because 346 people have died in two separate crashes with the 737 Max. We don't know what all of the answers are, and we don't know why. But it is important to know that companies like Boeing, the airline companies, operate in what you would call a zero-defect-tolerance environment. You can't have things go wrong in the air and have them say, "Oh, sorry. Something happened. We'll get it right next time."

There are a lot of questions about how and the process by which the 737 was approved for flying, whether Boeing cut some corners in terms of making sure that it got up as quickly as possible. It's a very, very important program for Boeing, because they were coming up against some real competition from Airbus for super fuel-efficient planes. This is a big deal for Boeing. It's obviously a big deal also for the scores of airlines that have bought the 737. The 737 is essentially the main platform for short and medium-haul flights.

There are a lot of questions out there right now. We're going to get some answers from the Ethiopian officials about the crash that happened two weeks ago in Ethiopia with a Boeing 737. Essentially, every country on Earth now has been grounding their planes. This is a rough developing story. It doesn't look that good for Boeing. The airlines will get some blowback. And I've seen, for the first time, people were using the words "regulatory capture" to discuss how it is that Boeing got this plane up into the air with the system that had not been checked.

Greer: Yeah, that's one of the things right now -- in fact, Congress as of today investigating. We've got hearings on that relationship between FAA and Boeing. Pretty cozy relationship.

Mann: Yeah. Regulatory capture is something that happens in a bunch of industries, but I can't think of one more than aircraft where, in the United States, there really is only one massive player, and then a bunch of smaller ones. You could see exactly how Boeing and the FAA would have to, for better, cooperate very closely. But in this case, pilots got no additional training on this warning control, what's called the stall prevention system. Airlines had to pay extra to get a sensor installed, and a lot of airlines didn't choose to do it. You could blame the airlines, maybe, but they didn't necessarily know that this was a huge or even a substantial change in protocol.

Greer: Yeah. It seems to me, Bill, when you think about all that, especially given the loss of life and all of the bad attention, the negative attention, that Boeing is getting, it's not in their interest to cut corners.

Mann: That's the thing that baffles me. I think, as analysts, we want to say, "Hey, we have the answers all the time." I think for companies, they want to be seen as having all the answers all the time. But you're talking about a new piece of safety equipment. The best explanation that I can come up with is that they just didn't realize, maybe, that this was such a change in the engineering. But the whole reason it's there is because the new 737 Max [planes] have such larger engines that they knew, just from the aerodynamics, that in certain environments it would be harder to fly. So I don't find the really benign explanations to be all that credible.

Greer: When you think about the airlines -- bringing it back to Southwest -- what do you think about investing in the airlines right now? A lot of consolidation in recent years. Historically, not been a great investment.

Mann: I'm actually pretty positive on certain airlines right now. We've talked in the past about my love for owning, but not necessarily flying, Spirit Air. Yeah, the airlines, it's a different environment than it used to be.

Greer: Spirit is a discounter, right?

Mann: Spirit is a discounter.

Greer: Bill Mann does not fly discount, is that it?

Mann: Well, I am 6'3. I'm not exactly built for the 28-inch seats and things of that nature.

Greer: Criss-cross applesauce.

Mann: That's right. [laughs] From a structural perspective, I'm not exactly their target customer.

Greer: OK. Speaking of structural perspectives, time to talk inverted yield curve.

Mann: That is a terrible segue. That's no good at all!

Greer: That's my signature. OK, Bill, last week, the yield on the 10-year Treasury dipped below the yield on the three-month Treasury note. Now, that was the first time that's happened since 2007. So, voila, we now have an inverted yield curve.

Bill, if people are hearing that phrase for the first time, or they've heard it and they don't really have a sense of what it's all about, why all the fuss?

Mann: The yield curve is basically, as both of those words suggest, how much money the average investor demands to get in return for loaning its money to the U.S. government for a certain period of time, anywhere from three months to 10 years. Generally, a regular yield curve, the longer you're loaning, the more you want in return. There are periods of time in which you will see the yield for shorter-duration notes rise above the longer term. Usually speaking, it doesn't make any sense. You would simply expect that the longer you lend, the more you want back. It generally happens when people are expecting a change in the short term now.

Over the last seven recessions in advance of each of them -- including, as you said, this one from 2007, and I hear that things weren't very great after that -- the recessions have been preceded by an inverted yield curve.

Now, it's important to say that the reverse isn't true. There have been a bunch of false positives. I think in this case, the thing that people need to pay attention to is that overall, the absolute base of the rates, is still extremely low. It's a different environment.

Greer: OK, so it can point to a recession. But it's one data point for investors.

Mann: It's a data point for investors. But keep in mind, this isn't just a data point. This isn't some ratio. This is actual, real-life, how much money do you demand to lend? How much money do you have to pay to borrow? So there are some real-world implications for it. But I think the fact that there are as many interpretations for what the inverted yield curve means as there are people putting out opinions about them should suggest very strongly that people don't really know. But, because it is something that doesn't happen that often, and does happen before a recession, people do pay attention to it.

Greer: Is there a Bill Mann recession indicator? Do you have any proprietary indicator, or something that you look at and say, "You know what doesn't get enough attention? _____."

Mann: Is how many boxes end up on my front doorstep because my wife has been shopping. You're welcome to drive by -- no, just kidding. I'm sorry, honey! I shouldn't have gone there right now! [laughs]

Greer: We can edit that out.

Mann: No, no. I tend to think of most of the indicators that people look at as being meaningful but not necessarily being all that predictive. For the markets, we pay attention to the amount of money that's on the sideline vs. the amount that's in the market at any given period of time.

The yield curve is important. I don't want to sound like I'm saying, "Hey, people are just making this up!" It is something to pay attention to. Eventually, there will be a recession. I can nearly guarantee that it will be preceded by the yield curve inverting itself. We just don't know that it's necessarily this time.

Greer: Bill, in an interview on Wednesday, Tesla's new chairman Robyn Denholm says that Elon Musk -- you've heard of him?

Mann: I have heard of him.

Greer: There you go. She says that Tesla founder-CEO Elon Musk, he uses Twitter wisely, and that he poses no corporate governance challenges. Let that just register. Now, Denholm became chairman in November. For those who may just be catching up with this story, in August, Elon Musk tweeted that he had secured funding to take the company private. That tweet caught the attention of the SEC. A settlement was reached in September. Bill, what do you think about her statement that Musk uses Twitter wisely?

Mann: I am so glad that Baghdad Bob has found a new job as the as the Chairman of the board of Tesla.

Greer: She also said I've been losing weight. [laughs]

Mann: [laughs] Mac, you're very attractive! [laughs] I find this simply amazing. I mean, I don't know what else she would say, but --

Greer: "Quit using Twitter"?

Mann: Quit using Twitter. But in public, I think that probably her best course of action would be to not bring this up, and not bring attention to the fact that he is supposed to have his tweets reviewed by someone. Who knows if he does or doesn't? It matters because a month ago, he put out one that was factually incorrect that he then corrected. I know, having been in a regulated environment here at The Motley Fool, that's not the way that works. Everything that we do is very, very closely considered. We just do not, at all, ever want to do what I describe as ringing a dinner bell at the SEC. But he doesn't seem to care.

In her role, I don't know what else she would say, but I think nothing may have been the best course of action.

Greer: Yeah. Questionable decision. Bill, we're going to close with what I know is one of your favorite stories, because you came by yesterday and you pointed this story out to me.

Mann: I cackled!

Greer: It's tremendous! I'm going to read the headline straight from Boing Boing. I'm going to let you put some meat on the bone here. Here's the headline: "Man Stole $122m from Facebook and Google by Sending Them Random Bills, Which the Companies Dutifully Paid."

Mann: [laughs] Can we start with the fact that this is $122 million?

Greer: So, not insignificant.

Mann: Not insignificant!

Greer: How did this scam go down?

Mann: He's a Lithuanian man, his name is Evaldas Rimasauskas. Evaldas Rimasauskas?

Greer: We're going to go with that [pronunciation].

Mann: Thank you! I said it right the second time! He basically figured out that there was a large Taiwanese computer company that was one of their largest vendors. He founded a company by the same name, but in Lithuania, and got all of the documentation, forged all of their corporate identities, and just started sending invoices.

Greer: Which is illegal, we should point out.

Mann: We should point out that this is at least heavily frowned upon.

Greer: Yeah, we're not sanctioning this.

Mann: No! Not at all! But, here's the amazing thing, besides the $122 million. So, he got caught, he's going to go to jail for upwards of 30 years for wire fraud. He has to repay $50 million.

Greer: OK, hold on, hold on, hold on! I thought you just said $50 million. In my read, I said he stole $122 million.

Mann: This is exactly what I'm saying. [laughs]

Greer: So, back of the envelope, $72 million --

Mann: How is this not getting focused on?!

Greer: Oh, my gosh!

Mann: $73 million, he doesn't have to pay back! I'm sure Michael Avenatti, who just got picked up for trying to defraud Nike for a couple of million dollars, is going, "Gosh, I wish I thought of that. That's great!"

Greer: Yeah. He may be involved in this. We don't know yet.

Mann: He's going to be involved in the next one, perhaps.

Greer: Oh, my gosh! Well, there you go. Facebook and Google, spend a little more time on the bill paying. But, how do you know if he's forging the letterhead and all that?

Mann: Yeah! I mean, obviously, there is a process by which bills get paid. He did go after them in a fraudulent way. But I don't know, when I pay my bills, I check where they're being sent!

Greer: Yeah, that's true. I just picture someone writing a check, looking at the address, the letterhead --

Mann: "Eh, it could be in Lithuania!"

Greer: Maybe they should switch to some sort of electronic bill payment. That's what I'm thinking. I mean, they're Facebook and Google! Come on! Use PayPal or something! The war on cash.

So, it's a little unfair. I always wrap up with the desert island question, where I take all the stocks we've mentioned and I say, if you were on a desert island -- of course you're not, but if you were -- and you were going to buy one of these stocks for the next five years, which one would you buy? It's not the way that anyone should invest. But, you know what? We're going to do it.

Mann: I think I want to buy stock in this guy! [laughs]

Greer: OK, there you go. That's true. That can be an option. You have Boeing, Southwest, Google, Facebook, Tesla, or this guy.

Mann: I'm actually going to stick with Southwest.

Greer: Interesting!

Mann: Airline companies. Or Google. Google pays its bills on time, apparently. That's good news. You know what, I'll switch, I'll say Google/Alphabet is the desert island company. Though, I do hope they are somewhat more careful with their accounts payable department in the future.

Greer: OK. Duly noted. You can always email us with your opinions, your questions, your thoughts, your feedback. marketfoolery@fool.com is our email. Bill Mann, thanks for joining me!

Mann: Glad to be here, Mac!

Greer: As always, people on the show may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's it for this edition of MarketFoolery. The show is mixed by Austin Morgan. I'm Mac Greer. Thanks for listening! And we will see you tomorrow!

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Bill Mann has no position in any of the stocks mentioned. Mac Greer owns shares of Alphabet (C shares) and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Facebook, NKE, PYPL, Southwest Airlines, SAVE, Tesla, and TWTR. The Motley Fool has a disclosure policy.