Do Stocks Decline after Yield Curve Inversions?

April 30, 2019 — Leave a comment

In late March the yield on short-term bonds (3-month) was higher than longer-term bonds (10-year) for a week. Normally you would expect higher returns for offering a 10-year loan than for offering a 3-month loan, leading to an upward sloping curve of yields of bonds of different maturities. What we saw in late march is called a “yield curve inversion” – longer-dated bonds providing lower yields than shorter ones. This often occurs when the Fed raises short-term rates fast relative to current conditions, and can be a precursor to a recession. It was true in both 2000 & 2008. Should you expect a decline to start soon? No. There is usually a significant lag between the inversion and stock declines. Here are the returns between the inversion and the stock decline for the S&P 500 and Extended-Term Component (ET) in the 2 prior cases of 2000 and 2008:

Inversion 1 Peak 1 Duration S&P 500 Return ET Return
9/30/1998 1/31/2000 16 months +39% +165%
01/31/2006 10/31/2007 21 months +18% +95%

1 I used month-end dates, given better access to historic return data on a monthly basis. The missing/extra partial-month impact on the results should be minimal.

These ET surges that are typical leading to peaks are a reason for you not to be concerned, and even be optimistic. Additional thoughts:

  1. Leading to peaks, ET tends to significantly outperform the S&P 500. It is great for your risk plan to be in a much stronger position in the face of future declines.
  2. The recent inversion was very short-lived, and current interest rates are still very low historically. It is possible that a recession is even further away than typical after inversions.
  3. While the statistics above provide a reason for optimism, I continue to be prepared for declines at any point – there are no guarantees on timing and results in investing.
Disclosures Including Backtested Performance Data

Subscribe

* indicates required Email Address * First Name Last Name Marketing Permissions Quality Asset Management will use the information you provide on this form to be in touch with you and to provide updates and marketing. Please confirm that you would like to hear from us by email:
Email
You can change your mind at any time by clicking the unsubscribe link in the footer of any email you receive from us, or by contacting us at [email protected] We will treat your information with respect. Please refer to the Newsletter Privacy Policy (see link near the top of this page) for more information. By clicking below, you agree that we may process your information in accordance with these terms. We use Mailchimp as our marketing platform. By clicking below to subscribe, you acknowledge that your information will be transferred to Mailchimp for processing. Learn more about Mailchimp's privacy practices here.

Gil Hanoch

Posts

No Comments

Be the first to start the conversation.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.