This inversion has been heralded by many as a recession indicator.
In fact, according to Credit Suisse, there have been five inversions of the 2-year and 10-year yields since 1978. All were precursors to a recession.
That said, there is a significant lag time between the inversion and the recession itself. The ensuing recessions occurred, on average, 22 months after the inversion. And during that time, the S&P 500 actually climbed – posting average returns of 15% over a period of 18 months after the inversion.
The last time this key part of the yield curve inverted was in December 2005, two years before the recession hit.
News of this morning’s inversion is rattling markets. As I write Wednesday mid-day, the Dow is down 600 points. Starting from our peak back in late July, the S&P has now sold off around 6%.
But taking a step back, what does all this really mean?
It’s a bit of a mind-melt … We now have calls for an impending recession … but until then, 15% gains for the S&P … Meanwhile, we’re in “correction” territory with the market down 6% – is it going to keep dropping? By how much? When do we bounce back?
Beyond that, some analysts are suggesting that “this time is different” in regards to this morning’s yield inversion. They suggest the drop in the 10-year Treasury yield is more reflective of international money pouring into the U.S. treasury market because of its strong yields (relative to lower and negative yields in international markets), rather than reflective of bad economic conditions in the U.S.
So What Does This Mean For The Stock Markets.
After a short bullish head fake on Tuesday, the major indexes erased those gains and dropped to a new short-term low today. At this point, we can safely say that the selling that started on July 31st is a “correction.”
The current decline has so far maxed out with a loss of 6% on the S&P 500, which is a little less than the -7% loss during the last drawdown in May and June. Generally, technicians consider any decline of -5% or more to be a correction, and these losses are close to average over the last 10 years.
There are a lot of negative factors creating the weakness in the market, including an inverted yield curve – which usually precedes a bear market and correction by 10-18 months – slowing manufacturing in China and Germany, and of course the ongoing tariff war.
There has been 17 corrections since the market bottomed in early 2009 with an average decline of 9.81%.
There were a few outlier corrections that technically qualified as bear markets included in those 17 declines, like the 20% losses that took place in 2016, 2018, and in 2011, which was triggered by the European debt crisis.
On average, they lasted 61 days, but there were some outliers in that respect as well with the 2011 correction lasting 157 days.
Despite the broad range of losses and length, the historical numbers can still help us establish a benchmark for the current correction when investors may want to take further action.
For example, 76% of the corrections that dropped at least 7% led to losses of more than 12%. So, if the current decline closes below 2800 on the S&P 500, short trades or other protective strategies are warranted.
What is really happening is that the U.S. is the haven economy in a world where Europe is in trouble and the leading economies of Asia are slowing. And as a result, yields for government bonds from the leading issuers in Europe and Asia are increasingly heading into negative yields.
Negative yields and interest rates around the world beyond the U.S. are rapidly becoming a growing problem as the amount of bonds with negative yields keeps climbing by the day to a current level of $15.83 trillion.
This in turn is making the U.S. bond market all the more attractive with positive yield and in turn is driving more buying from investors inside the U.S. and beyond. And with more buying of longer-term bonds – yields are down, and prices are up.
Should You Be Worried?
Most likely, we will not be seeing a recession. Secondly, bitcoin should continue to rise as an alternative store of value.
The U.S. isn’t just a haven – it is a powerhouse. It stems from the 2016 elections. There have been numerous major industry deregulation and regulatory reforms which have unleashed investments and profits fueling growth from financials, petroleum, industrials, utilities, real estate – especially REITs with the tax cut.
This is what Europe and Japan need to get their economies back on recovery. And it’s why the U.S. economy was hobbled for years after various legislative and more so capricious administrative application of regulations.
All of the great efficiencies in the U.S. economy are what is behind the low and falling inflation, thanks to so much investment in so many varied industries – particularly in the application of technology to all sorts of businesses and industries.