Pennsylvania Trust

A Note On The Yield Curve Inversion And Market Reaction

A Note On The Yield Curve Inversion And Market Reaction

“History doesn’t repeat itself but it often rhymes.”

Today’s inversion of a key part of the yield curve is an indicator that should not be ignored. While an inversion does not cause a recession, it usually predicts one. A yield curve inversion has preceded the past seven recessions (back to 1970) by an average of fifteen months (according to a note from BAML).

This being said, the stock market does not necessarily roll over immediately. Since 1970 there have been a total of ten times when the spread between the two year and ten year Treasury yields turned negative for the first time. On six of the ten times, the S&P hit a peak within three months while on the other four times the market rally continued for as much as two years… Interestingly, the time from inversion to recession has been lengthening as the last three times the curve inverted for the first time in the cycle, stocks continued to rally, and the recession was more than 19 months out.

While much can be debated on the reason for the current inversion (from extraordinary central bank policies, global recession fears, to the trade war), we remain constructive on the U.S. economy and do not believe anything fundamentally has changed based on the yield inversion. We continue to believe the economy is slowing and recession probabilities are rising hence believe a balanced, diversified (among asset classes) view remains the most prudent way forward.

While we acknowledge that global economic pressures will persist and that geopolitical issues (trade war, Brexit, U.S. elections) will be a part of the investment landscape for the foreseeable future, we firmly believe the U.S. economy is on solid footing and the Fed is likely to do what will be needed to avoid a near term recession. As investors, we are naturally upset by severe market reactions but must remind ourselves that volatility is normal and that in a healthy economy we should use these moments as an opportunity to find investments that are undervalued.

 

Inversion DateS&P PeakS&P Return (Inversion to Peak)Recession Started
12/27/200510/9/2007

28.77%
December 2007
3/24/19983/24/2000

41.88%
March 2001
12/14/19887/16/1990

41.39%
July 2009

 

 


Disclosure: This Commentary represents a review of topics of possible interest to Pennsylvania Trust’s clients and is not personalized investment advice. It contains Pennsylvania Trust’s opinions, which may change following the date of publication. Information obtained from third-party sources is assumed to be reliable but is not guaranteed. No outcome – including performance – is guaranteed, due to various uncertainties and risks. This document is not a recommendation of any particular investment. Investment decisions for clients are made on an individualized basis and may be different from what is expressed here. Past performance is no guarantee of future results.