The Treasury yield curve is flattening, which has some investors and traders turning bearish. Most people focus on the 10 year – 2 year yield curve, which is close to inverting.
*Investors and traders only need to be careful once the yield curve inverts. A flattening yield curve on its own means nothing until it becomes inverted.
As you can see, the 10 year – 2 year yield curve is close to being inverted. It currently stands at 0.24%
HOWEVER, the 10 year – 2 year yield curve isn’t the best yield curve. The 10 year – 2 year yield curve tends to become inverted too early, which means that it becomes bearish too early.
The 10 year – 3 month yield curve is a better yield curve because it tends to invert later. When it inverts, it gives you a more timely SELL signal. The 2 year Treasury yield tends to be higher than the 3 month Treasury yield.
The 10 year – 3 month yield curve is still far from being inverted. It recently fell to 0.83%
When the 10 year – 3 month yield curve falls to 0.83% for the first time in an economic expansion cycle, the stock market usually continues to go up.
Here’s another way to visualize the S&P 500’s 2 year forward returns when the yield curve flattens to 0.83%.
Click here to download the data in Excel.
June 27, 2005
The stock market rallied for 2 more years before topping in 2007, even though there were multiple “small corrections” along the way.
May 24, 1995
The stock market went up over the next 5 years before topping in 2000. There was a “big correction” and multiple “small corrections” along the way.
January 17, 1989
The stock market rallied for another 1.5 years before starting a “big correction”, which the Medium-Long Term Model predicted.
September 30, 1980
The stock market rallied for another 2 months. Then it swung sideways for the next half year before starting a “big correction”.
September 1, 1978
The stock market rallied for the next 2 years, even though there were multiple “small corrections” and a “big correction” along the way.
January 24, 1973
The stock market started a bear market when the 10 year – 3 month yield curve flattened to 0.9%
July 9, 1963
The stock market rallied for 5.5 more years before a bear market. There was a “big correction” and multiple “small corrections” along the way.
The 10 year – 3 month yield curve is a better yield curve. Based on where it is today, the stock market will probably continue to rally in the medium-long term.
There is only 1 terriblybearish case out of these 7 historical cases. That was due to OPEC’s oil embargo. Unless Trump’s trade war results in a global catastrophe and recession, that bearish case is unlikely to play out today.
Trump’s trade war with China is expected to shave less than -0.2% off of U.S. GDP growth. With the U.S. economy growing at 3-4% a year, this trade war will not have a big impact on the economy.
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