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In macroeconomics, the yield curve is used to forecast the probability of a recession. When the curve becomes inverted, it means that short-term yields are higher than long-term yields which, up until last week , had been the case for over two years. This puts investors on edge because an inverted yield curve has historically given way to recessions. The lead time can be quite significant from when the inversion ends, but investors are reasonably worried about the implications for the stock market. We look at the relationship through a technical lens. We can chart the yield curve by subtracting 2-year U.S. Treasury yields from 10-year U.S. Treasury yields. When the yield curve turns positive after having been negative for an extended period, it has been a precursor of recessions, albeit with a small sample size. Note the yield curve just shifted positive after a prolonged inversion, so it is timely to consider the macroeconomic landscape. Looking back 40 years, there are only three prior occurrences where the yield curve turned positive after a prolonged period of inversion: 1989, 2000, and 2007. From a technical perspective, we are most interested in how the yield curve “signal” works from a market timing perspective pertaining to the stock market. The three occurrences all led to recessions, but with variable lags, and the impact on the S & P 500 Index has also varied with the three instances: In June 1989, the yield curve turned positive, leading to a cyclical bear market into late 1990 with a drawdown of roughly 20%. However, the signal was early, as the SPX rallied another 10% into October 1989. The yield curve also signaled the bear market during the Great Financial Crisis, but the signal was 7 months early and the SPX rallied nearly 10% before peaking. The most timely signal was in late 2000, which roughly coincided with the start of a bear market cycle. In conclusion, the yield curve has indeed signaled recessions and bear markets in the past, but we would not rely on the yield curve by itself due to the lead-lag relationship of financial markets and the economy. Also, the small sample size of the signals reduces statistical legitimacy. A solution to these drawbacks is to utilize technical analysis to confirm the signal from the yield curve. When long-term momentum indicators roll over for the S & P 500, the bearish yield curve signal is made more concerning. —Katie Stockton with Will Tamplin Access research from Fairlead Strategies for free here . DISCLOSURES: (None) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . 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https://www.cnbc.com/2024/09/09/katie-stockton-on-when-investors-should-start-worrying-about-the-yield-curve-recession-signal.html
