Yield Curve Inversion: A Bad Sign for Stocks

The yield curve has been inverted for 120 trading sessions

Senior Quantitative Analyst
Apr 12, 2023 at 8:00 AM
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Typically, interest rates on long term bonds are higher than rates on short term bonds. An inversion of the yield curve means the short-term rates became higher than the long-term rates. It’s a well-known predictor of economic recessions. The 10-year and 3-month treasury yield spread became inverted last October (I wrote about the yield inversion in November).

Well, it’s still inverted. This week, I’m going to rehash some numbers on the stock market after yield curve inversions and after the persistence of a yield curve inversion.

The chart below shows the difference between the 10-year and 3-month treasury yields. Based on our data, it’s the most inverted it has been since the early 1980’s. It’s been inverted for 120 trading days, which would be the third longest streak since then.

Iotw Apr11 Chart 1

Yield Curve Inversions--Past and Present

The chart below shows the entire yield curve at different points in time over the past 20 years. You can see how the current yield curve moves lower as you go further out in time. We have 3-month yields just above 5%, and they gradually fall the longer the maturity until a slight move higher from the 10-year to 30-year yields. Typically, the shorter the time to maturity, the lower the yield.

IotW Apr11 Chart 2

The table below shows why an inverted yield curve is considered a cause for concern. After 14 yield curve inversions since 1989, the S&P 500 Index has averaged a middling 1.4% return over the next year, with 57% of the returns positive. The average one-year return anytime for the S&P 500 has been over 9%, with about 80% of the returns positive.

Iotw Apr11 Chart 3

The persistence of the yield curve inversion sets this time apart from many other inversions. As previously mentioned, this spread has been inverted now for 120 straight trading days -- its third longest streak since at least the early 1980’s. The table below lists these occurrences. The last time was in early 2007, about ten months before the stock market peak, just before the financial crisis. The S&P 500 was barely negative one year later and was down 40% over the next two years. The time before that was in early 2001, when the tech bubble was bursting. The S&P 500 fell 11% over the next year and nearly 30% over the next two years. Hopefully, we don’t see similar results this time.

IotW Apr11 Chart 4

 

 

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