Picture This!

I follow Liz Ann Sonders on Twitter (@LizAnnSonders). Liz loves pictures! Namely, she loves graphs and knows a picture really is worth a 1000 words. Lately, Liz has been posting pictures of the yield curve.

What is this thing we call "the yield curve," and why do we pay it such homage? The yield curve is a graph of a bond's interest rate (yield) and its time to maturity. Normally, you would expect yields on short-term bonds to be lower than yields on long-term bonds, right? After all, there is more risk in holding a long-term bond, so investors should expect a little something extra for their trouble.

But sometimes that curve gets a little whacky, and that's when investors take note. When the yield curve changes from its normal upward slope to something more akin to a flat line, that often signals trouble ahead. Liz shares her thoughts on the yield curve in her blog. She looks at the history and the current economic indicators that are shaping this curve.

A flat curve means investors are expecting rates to be lower in the future. So what? Well, lower future rates usually accompany recessions or economic slowdowns. On Friday, the yield curve went beyond flat to an inversion. That's when shorter-term bonds are yielding MORE than longer-term bonds. Yield curve inversions are like flashing red lights at the railroad crossing. So investors pulled back and got off the tracks resulting in a 2% decline in markets.

Will the trend continue? We don't know. Economies around the globe are slowing, but the US is still holding up. But there are some worrying signs. Just today, we see that housing starts dropped 9% in February and housing price gains are slowing. Our long bull run is still rewarding investors, but it's starting to experience fits and starts.

So keep your eye on that yield curve. Flat lines may nudge investors, but inversions cause us to sit up and pay attention. While not every inversion signals an upcoming recession, every recession has been preceded by an inversion. If you want to have a little fun, check out the dynamic yield curve. This shows the changing curve alongside the stock market.