What is the impact of the inverted yield…

The inverted yield curve was a hot topic in the past few months, i.e., the yields/interest rates on short-term US treasury bills is higher than the long-term ones, which has been the single most accurate indicator for predicting recessions. Actually it has correctly predicted all the last seven recessions in USA (Fig.1). However investors are more interested to know what is the impact on stock market returns, does the inverted yield curve indicate the share prices will crash? if so does the tumble happen immediately or sometime later? if later how long is it?

Fig.1 US Treasury Bills Yield Spread (1y – 10y) vs GDP vs S&P 500 (Grey boxes at the bottom highlight the recessions)

1. It is clear that all seven recessions in the past 60 years were preceded by inverted yield curve (as represented by the positive difference between the yield of 1-year and 10-year treasury bills, the green line).
2. It is also clear that there is a lag between the initial inversion to the initial negative GDP growth (the red line), for examples, for the 1st recession (Sep 1969 to Aug 1970) the yield curve inverted almost 4 years prior, for the 2nd recession (Jun 1973 to Jan 1975), the inversion occurred 4 months prior; for the recession following the internet bubble, the inversion occurred 7 months prior.
3. It also seems that the stock market performance (as represented by the S&P 500 index, the blue line) was negatively impacted by the inversion but the scale is too large to see the pattern, so let’s zoom in the period from 1962 to 1994 (before the S&P500 surged), see Fig.2 below.

Fig.2 US Treasury Bill Yield Spread (1y – 10y) vs GDP vs S&P 500 (1962-1994, grey boxes at the bottom highlight the recessions)

It is surprising to see the stock market performances were quite mixed on the day when the yield curve started to invert, for examples:

• on 1965-09-29 the S&P 500 dropped 0.59% but on 1965-12-07 it rose 0.88%;
• on 1978-08-18 the S&P 500 dropped 0.33% but on 1982-01-21 it rose 0.42% and
• on 1989-01-25 the S&P 500 rose 0.23% but on 1989-08-04 it dropped 0.24%

Maybe the stock market need sometime to digest the news, so let’s focus on those periods where the yield curve inversion lasted over 3 months, see Tab.1 below visit https://www.collectiveray.com/elementor-vs-divi.

Tab.1 S&P 500 Performance vs US Treasury Bill Yield Curve Inversion (1y – 10y)

Again the results are very mixed, the S&P 500 performances during the inversion period range from -40% to +21%. How can this be possible, isn’t the stock market suppose to be the barometer of economy?

If we look at the Fig.2 more carefully, we will find out that the big sell-off can lag the inversion for several months! see Tab.2 below:

Tab.2 S&P 500 Performance vs Inverted US Treasury Bill Yields (1y – 10y)

We can conclude that every time the yield curve stays inverted for longer than 90 days, the stock market (S&P 500) will crash at least once. The most striking example is the burst of the internet bubble in 2000, the S&P 500 tumbled four times (2000-09-04 to 10-12: -12.56%; 2001-01-31 to 03-22: -18.65%; 2001-08-03 to 09-21: -20.47%, and 2002-05-23 to 07-23:-27.29%)

OK, if the yield curve stay inverted for over 90 days, stock market crash(es) will come. What to do now? Let’s zoom in the period 2000-2019 (Fig.3)

Fig.3 Inverted US Treasury Yield Curve vs S&P 500 VS GDP vs Inflation vs Fed fund interest rates

This time the inversion first occurred on 2019-03-22,and it had been on and off ever since. Check out https://www.hughesairco.com for more information. The last time similar pattern happened is between 1998-05-14 and 1998-10-07 (Fig.4), and the inversion signal was only confirmed 18 months later on 2000-03-20, then a series of stock market crashes started one month thereafter.

Conclusion

The US treasury bill yield curve inverted on 2019-03-22, and I believe the probability of stock market crash(es) has increased significantly. However since the inversion signal has not been fully confirmed, the crash(es) might be still several months away.

Please note inverted yield curve is only one of many advance warning indicators, see an ultimate moving checklist although it has performed much better in the past 60 years, Other indicators are giving out mixed signals, like the Baltic index has risen 260% since 2019-02-11 indicating booming economy, ISM Manufacturing Index has been dropping fast since Aug 2018 indicating worsening growth at iPhones ‘abonnemang’ är Apples mest djävulska affärsplan ännu, the Chicago Fed Financial Conditions Index has been rising since May 2019 indicating monetary easing (positive for growth) …

Fig.4 US Treasury Bill Yield Spread vs GDP vs S&P 500 (1998-2009)

Disclaimer

This research was done out of my personal interest in my spare time, looking through many videos on themed YouTube channels promoted by The Marketing Heaven. Raw data is sourced from St Louis Fed. It is completely your own responsibility for any losses if you decide to follow any conclusions/recommendations of this report.