Most Popular
1. THE INFLATION MONSTER is Forecasting RECESSION - Nadeem_Walayat
2.Why APPLE Could CRASH the Stock Market! - Nadeem_Walayat
3.The Stocks Stealth BEAR Market - Nadeem_Walayat
4.Inflation, Commodities and Interest Rates : Paradigm Shifts in Macrotrends - Rambus_Chartology
5.Stock Market in the Eye of the Storm, Visualising AI Tech Stocks Buying Levels - Nadeem_Walayat
6.AI Tech Stocks Earnings BloodBath Buying Opportunity - Nadeem_Walayat
7.PPT HALTS STOCK MARKET CRASH ahead of Fed May Interest Rate Hike Meeting - Nadeem_Walayat
8.50 Small Cap Growth Stocks Analysis to CAPITALISE on the Stock Market Inflation -Nadeem_Walayat
9.WE HAVE NO CHOICE BUT TO INVEST IN STOCKS AND HOUSING MARKET - Nadeem_Walayat
10.Apple and Microsoft Nuts Are About to CRACK and Send Stock Market Sharply Lower - Nadeem_Walayat
Last 7 days
AI Tech Stock PORTFOLIO NAME OF THE GAME - 29th June 22
Rebounding Crude Oil Gets Far Away from the Bearish Side - 29th June 22
UK House Prices - Lets Get Jiggy With UK INTEREST RATES - 28th June 22
GOLD STOCKS ARE WORSE THAN GOLD - 28th June 22
This “Bizarre” Chart is Wrecking the Stock Market - 28th June 22
Recession Question Answered - 28th June 22
Technical Analysis: Why You Should Expect a Popularity Surge - 28th June 22
Have US Bonds Bottomed? - 27th June 22
Gold Junior Miners: A Bearish Push Is Coming to Move Them Lower - 27th June 22
Stock Market Watching Out - 27th June 22
The NEXT BIG EMPIRE WILL BE..... CANZUK - 25th June 22
Who (or What) Is Really in Charge of Bitcoin's Price Swings? - 25th June 22
Crude Oil Price Forecast - Trend Breaks Downward – Rejecting The $120 Level - 25th June 22
Everyone and their Grandma is Expecting a Big Stocks Bear Market Rally - 23rd June 22
The Fed’s Hawkish Bite Left Its Mark on the S&P 500 Stocks - 23rd June 22
No Dodging the Stock Market Bullet - 23rd June 22
How To Set Up A Business To Better Manage In The Free Market - 23rd June 22
Why Are Precious Metals Considered A Good Investment? Find Out Here - 23rd June 22
UK House Prices and the Inflation Mega-trend - 22nd June 22
Sportsbook Betting Reviews: How to Choose a Sportsbook- 22nd June 22
Looking to buy Cannabis Stocks? - 22nd June 22
UK House Prices Momentum Forecast - 21st June 22
The Fed is Incompetent - Beware the Dancing Market Puppet - 21st June 22
US Economy Headed for a Hard Landing - 21st June 22
How to Invest in EU - New Opportunities Uncovered - 21st June 22
How To Protect Your Assets During Inflation - 21st June 22
AI Tech Stocks Current State, Is AMAZON a Dying Tech Giant? - 20th June 22
Gold/Gold miners fundamental checkup - 20th June 22
Personal Finance Tips: How To Get Out Of A Tough Financial Situation - 20th June 22
UK House Prices Relative to GDP Growth - 19th June 22
Will Global Markets Be Pushed Deeper Into Crisis Event By The US Fed? - 19th June 22
Useful Things You Need To Know About Tweezer Top Candlestick Pattern - 19th June 22

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Last Time the Yield Curve Inverted, Stocks Soared 30%!

Stock-Markets / Stock Markets 2019 Jan 04, 2019 - 04:28 PM GMT

By: John_Mauldin

Stock-Markets Everybody is suddenly talking about the inverted yield curve.

They’re right to do so, too, but alarm bells may be premature. Inversion is a historically reliable but early recession indicator. Even a fully inverted yield curve—which is not yet—isn’t saying recession is imminent.

What we see now is really more of a flattened yield curve. It has a smaller but still positive spread between short-term and long-term interest rates.

That’s not normal, but it’s also not a recession guarantee. However, when we combine this with other threats, it adds to the concerns.


I’ve been writing in Thoughts from the Frontline about negative yield curve since 2000. Back then the inverted yield curve predicted a recession and I called a bear market in equities.

Ditto for 2006. That time the yield curve inverted long before the stock market turned, though.

Let’s look at what the yield curve is really telling us this time.

An Inverted Yield Curve Is Just a Fever

I’ve been using an analogy in my speeches recently that has received excellent feedback, so I want to share it with you.

Many media sources and writers seem to indicate that an inverted yield curve causes recession. That is simply not true.

Think of an inverted yield curve as a fever. When your body gets a fever, the fever is not the cause of the sickness. It just says something’s wrong with your body. You have the flu, appendicitis, or some other ailment.

The fever indicates you are sick but not necessarily what the sickness is. And typically, the higher the fever the more serious the condition.

It is the same with the yield curve. The more inverted the yield curve is and the longer it stays that way, the more chances something is economically wrong. Which may later show up as a recession.

A true inversion last happened in 2005. Were we in recession then? No, not at all. The economy was booming.

In fact, the yield curve stayed inverted until mid-2007. Some of us saw cracks forming in the economy, and said so at the time. But the actual recession would not begin until December 2007.

That’s a longstanding pattern. The inverted yield curve has been a pretty reliable recession indicator but it shows up far in advance—months or even more than a year. We might better think of it as signaling the cycle’s “blowout” stage. People see the inversion, observe nothing bad happening, then throw caution to the wind.

Recession Probability Based on the Spread

This idea that an inverted yield curve signals recession isn’t new. Nor did it appear from thin air.

In 1996, New York Fed economists Arturo Estrella and Frederic S. Mishkin authored a paper that compared the yield curve to 19 other indicators.

To summarize, Estrella and Mishkin found the yield curve is most predictive of recession a year or so ahead of time. In fact, they concluded an inverted yield curve was the only useful predictor of recessions.

Examining all the data from 1960-1995, they calculated the probability a recession would occur four quarters ahead, based on the spread between three-month and 10-year Treasury securities. They summarized it in the table you can find here (page 2).

Estrella and Mishkin found recession probability begins rising as the spread drops toward and then below zero. But it takes a long time. Even when the curve mildly inverts with the spread at -0.17%, the odds of a recession in the next year are still only 30%.

But from a practical standpoint, by the time their model shows a 30 or 40% probability of recession, there has always been a recession following that point.

What the Yield Curve Is Telling Us This Time

The 3M/10Y spread is now about 0.48%.

The study suggests this is consistent with about a 15% recession probability four quarters from now. Not so bad, if you are a bull. It means odds are good we’ll get through 2019 without recession.

Maybe longer, if the Fed pauses tightening next year and long-term yields stay where they are. We are not out of the woods, though. We may just be entering them.

On the other hand, history never repeats itself quite so perfectly. Other things are different—all the European Threats I described last week, or the prospect of wider trade war as President Trump tries to make China change its ways.

I would not conclude from the yield curve that recession is either imminent or impossible. It says what I already knew: A recession will strike at some point, but we probably have a little time.

Also note that market corrections, even serious ones, don't always happen in a recession. That could be the case this time with more than half of S&P 500 stocks already in a bear market.

And we haven’t even got a widely expected Santa Claus rally.

The current sell-off tells us that valuations are way too high and markets are way too nervous.  If we do get an inverted yield curve and a recession on top, this bear market could be even worse than the last two—which were down 50%.

I have been telling everyone to be hedged and have a systematic way to control their downside risk for at least one year. Prepare to exit positions that may become illiquid, think of ways to hedge, and generally get ready for a volatile 2019.

Think of cash as an option in the future.

Join hundreds of thousands of other readers of Thoughts from the Frontline

Sharp macroeconomic analysis, big market calls, and shrewd predictions are all in a week’s work for visionary thinker and acclaimed financial expert John Mauldin. Since 2001, investors have turned to his Thoughts from the Frontline to be informed about what’s really going on in the economy. Join hundreds of thousands of readers, and get it free in your inbox every week.

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in