Uninverted, Not Inverted, Yield Curves Are the Bear Market Warning
Last summer, it was all anyone seemed to talk about. The inverted yield curve. Now, that story seems almost forgotten.
In August 2019, Fidelity published a helpful explainer:
“With yields on 10-year US Treasury notes having fallen below yields on 2-year notes for the first time since 2007, the phrase “inverted yield curve” has found its way back into the media and back into investors’ conversations.
It’s unusual for yields on fixed income securities that mature in the relatively near future to be higher than on those that mature at a more distant point in time, but it’s not the first time this year it’s happened. Yields on 3-month Treasury securities moved higher than those on 10-year notes earlier in 2019.
Conventional wisdom says that when the curve inverts, a recession is drawing near. But history shows that an inverted yield curve forecasts recession much in the same way that autumn forecasts winter: While one eventually follows the other, nothing indicates precisely when it will happen—or what to do about it. What an inverted yield curve does tell investors is that they should be cautious.” [1]
Fidelity’s article appeared at about the time interest in the term peaked according to Google. [2]
Source: Google Trends
The term was also popular among investors in December 2018 and March 2019, previous instances when various yield curves inverted.
The yield curve is no longer inverted and interest in the concept has declined.
Source: Federal Reserve [3]
Global Financial Data, a firm that specializes in providing Financial and Economic Data that extends from the 1000s to the present notes
“…each of the recessions since 1950 were preceded by periods when the yield on the 2-year note exceeded the yield on the 10-year bond. There was one case where no recession followed, in 1965 and 1966, but with that one exception, every dip into a negative yield spread in the past was followed by a recession within a year.
During the 1930s and 1940s, short-term interest rates were kept artificially low because of the Great Depression in the 1930s and World War II in the 1940s. If you go back to the 1920s, however, you can see that both the 1920-1921 recession and the 1929-1932 Depression were preceded by yield-curve inversions.
Moreover, seven of the nine bear markets since 1950 were preceded by a yield inversion. The 1962 Steel Crisis and the 1987 Stock Market Crash were not preceded by a yield inversion, and no bear market followed the 1969 inversion.
Given the evidence, the yield inversion between the 2-year note and 10-year bond is not a perfect indicator of future recessions and bear markets. However, over 80% of the time it does prove to be an accurate indicator.” [4]
GFD also notes, “the recession didn’t begin until the yield curve became positive again.”
This is yet another indicator warning of potential economic weakness in 2020. It could be wrong. After all, the inverted yield curve has only correctly forecast recessions over 80% of the time. It’s only accurately forecast 78% of the bear markets since 1950.
It could be important to watch for a bear market in the coming twelve months.
Regards,
Editor, Peak Velocity Trader
Sources
[1]: Fidelity – Are bonds signaling recession? [2]: Google Trends – Inverted Yield Curve [3]: Federal Reserve – 10-year Minus 2-year Treasury Yield Curve [4]: Global Financial Data – The Inverted Yield Curve in Historical Perspective
After spending nearly 20 years developing pattern recognition software for the United States Air Force, I retired from my military career in 2005. My plan was to utilize the same pattern recognition principals I used in the military and apply them to the largest and most lucrative market in the world: the stock market.
