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There are few things investors fear more than an inverted yield curve.
Why? 2 reasons…
Data Sources for all charts/tables herein: FRED, Bloomberg.
2. Weaker stock market returns tend to follow flat/inverted curves.
Note: yield curve range is based on (10-yr yield minus 1-year yield).
In December 2018, part of the yield inverted for the first time since 2007. At month-end, the 6-month Treasury bill yield stood at 2.56%, 5 basis points higher than the 5-year yield (2.51%).
Naturally, many investors are afraid, with 45% predicting an imminent recession in a recent poll…
Is this a reasonable expectation? Let’s take a look at the last 3 times the yield curve inverted in a similar fashion (6-month higher than 5-year) after a long period with a positive slope…
1) In December 2005, the yield curve inverted for the first time since 2000. The S&P 500 ended the month at 1,248. What happened next?
2) In August 1998, the yield curve inverted for the first time since 1989. The S&P 500 ended the month at 957. What happened next?
3) In March 1989, the yield curve inverted for the first time since 1981. The S&P 500 ended the month at 295. What happened next?
As we can see, there is no rule saying a recession has to start immediately after an inversion. The yield curve is a long leading indicator, and in the last 3 cycles it took between 16 and 31 months after inversion for a recession to start and between 16 and 22 months for the stock market to ultimately peak.
Does it have to take take that long?
No, there are no hard and fast rules in investing. Every cycle is different and just because something hasn’t happened in the past doesn’t mean it can’t happen in the future. A recession could start next month and the stock market could have already peaked (S&P 500 ended the year at 2,506, down from its September high of 2,940). But these are possibilities, not probabilities. The more probable path based on history seems to be that the expansion will continue for at least a little while longer and stocks will recover their recent losses.
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Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Charlie is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Charlie holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and also holds the Certified Public Accountant (CPA) certificate.
In 2017, Charlie was named the StockTwits Person of the Year. He has been named by Business Insider and MarketWatch as one of the top people to follow on Twitter and his work has been featured in Barron’s, Bloomberg, and the Wall Street Journal.
You can follow Charlie on twitter here.
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