At about 1:32 PM EST on Tuesday, the widely-followed spread between 10-year and 2-year treasury yields (a.k.a. the yield curve) briefly fell to -0.002%, thus inverting (even if barely) for the first time since 2019. It then “recovered” to close the day at 0.03%, which is roughly where it is at the time of writing. We could debate whether an intra-day inversion lasting about 1 minute should formally count as an inversion, but the point is moot. Given such slim margin of safety, barring an unlikely sudden change of tune from the Fed in a dovish direction, we should expect the yield curve to invert again soon. While a sustained yield curve inversion would have ominous implications for the economy down the road, an initial yield curve inversion doesn’t mean stocks are immediately headed for a bear market, quite the opposite in fact.
Looking back at history since the 1970s, we identified six separate cycles in which a yield curve inversion was followed by a stock market peak, which was then followed by a recession. In every single case, following the initial inversion of the yield curve, stocks went on to record double-digit gains before the bull market eventually peaked. The average gain was 28% and was achieved over an average period of 476 days (roughly 16 months). The yield curve inversion between the double-dip recessions of the early 1980s saw the smallest gains of 13%, which were also recorded over the shortest period of 78 days. At the opposite end of the spectrum, the 1998 inversion was followed by the largest gain of 43%, recorded over 829 days (over 2 years).
Every cycle is different and these numbers should not be used as an excuse to be complacent. However they do suggest that investors fleeing stocks as soon as the yield curve inverts may be leaving a lot of money on the table.
S&P 500 Total Return and Number of Days from Initial Yield Curve Inversion to S&P 500 Peak
The S&P 500 Index and the Yield Curve
Sauro Locatelli CFA, FRM™, SCR™
Director of Quantitative Research
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