Keeping the Yield Curve in Perspective
Written by: Ryan Bouchey
Tuesday we saw one of the worst days in the market for 2018, a year where we have experienced more volatility than we had otherwise been used to. The two main drivers of this were that investors and Wall Street began digesting comments from Trumps meeting with China, and more importantly the 2-Year Treasury Note and 5-Year Treasury Note yield curves had inverted – meaning the 2-Year Note was now yielding more than the 5-Year. Inverted yield curves have been on investors’ minds for most of the year and this proved to be a real selling point for most. It’s important to look at the realty of both situations.
First let’s debunk the fear coming from Trump & China. The news was mostly positive following Saturday nights sit down between the two leaders, President Trump and President Xi. Monday’s market rally reflected this with hopes of trade resolution. As more details became available and people read into the comments, it became clear that nothing had actually been resolved yet and there really wasn’t much to be excited about. While we hope trade issues and the tariffs get resolved, this doesn’t change anything from the week before. We aren’t in a worse trade situation all of a sudden. Because of this I think we should still be concerned over our trade relations with China; however, it shouldn’t be cause for a wide spread market sell-off.
Now let’s look at the main driver of Tuesdays sell-off: the dreaded inverted yield-curve. This has been the most talked about indicator of potential bear market / recession all year. We’ve even tackled it in a past quarterly webinar, which can be viewed here. Our focus in the past has been with the 2-Year and 10-Year inversion, which has historically been a good leading indicator of an economic recession. Tuesdays inversion had to do with the 2-Year and 5-Year, which has also been a good indicator. But if we look closer at recent history, the last three times this has happened a market sell-off wasn’t immediate.
- December 1988 the 2 and 5-Year yields inverted. The S&P peaked in July 1990 and a recession started at the same time of July 1990. Equities returned 37% from inversion to market peak.
- May 1998 – another yield curve inversion. The S&P peaked in March 2000 and a recession started in 2001. Equities returned 49% from inversion to market peak.
- November 2005 – 2 and 5-Year yields inverted. The S&P peaked in October 2007 and a recession began in December 2007. Equities returned 34% from inversion to market peak.1
We aren’t sharing this data to predict that markets are going to be up for the next day, week or even month. What we do want to share though is that as worrisome as an inverted yield curve has been for investors, it hasn’t historically indicated immediate doom in the stock market. I think it does tell us something about nearing market and economic peaks, but it isn’t an indicator that yesterday was the beginning of the end.
1Statistics listed on Charlie Bilello’s twitter account at https://twitter.com/charliebilello/status/1070122793407311872, and also confirmed using internal research.