[Update] Study: yield curve continues to flatten. A bullish sign for the stock market


The Treasury yield curve continues to flatten. The 10 year yield – 2 year yield is now at 0.3%. Or as the bears would have you believe, “the Fed is about to end the economy and stock market”.

Facts and data disagree.
This is the first time in the current economic expansion cycle in which the yield curve flattened to 30 basis points (0.3%). The yield curve needs to invert (i.e. 10 year – 2 year yield is below zero) before you get a bearish sign. Moreover, the stock market doesn’t always top when the yield curve becomes inverted. It sometimes tops months AFTER the yield curve becomes inverted. The yield curve is an imperfect indicator.
At the current pace, the Fed just needs to hike interest rates 1 more time before the 10 year –  2 year yield curve becomes inverted. This will most likely happen in Q3 2018 (this quarter). The stock market usually tops 6-12 months after that, which is why a major market top in 2019 is likely.
However, the key point is that at 0.3%, the flattening yield curve is STILL bullish for the stock market.

Here’s the data to prove it.
Here’s what happens next to the S&P 500 when 10 year – 2 year yield curve reaches 0.3% for the first time in each economic expansion cycle.

Click here to download the data in Excel.
As you can see, the stock market tends to go up in the 1 year after the 10 year – 2 year yield curve flattens to 0.3%
People don’t seem to understand the point of the yield curve. You don’t need to pay attention to whether or not the yield curve is flattening. All that matters is whether or not the yield curve is inverted (i.e. below zero). We demonstrated in this post that an inverted yield curve is not enough for picking tops in the stock market. Sometimes an inverted yield curve accurately calls the top in the stock market. Sometimes it is too early by up to 1 year. See study
*Note that this study uses the 10 year – 3 month yield curve, which gives a more accurate signal than the 10 year – 2 year yield curve. The 10 year – 3 month yield curve is still at 0.85%. This more important yield curve will probably invert at the end of 2018.

Conclusion

As you can see, the yield curve is still sending a medium-long term bullish sign for the stock market. It says that:

  1. The stock market will probably trend higher for another year or so, after which…
  2. The yield curve will invert and an equities bear market will start (probably in 2019).

There is only 1 long term bearish case: 1973. That bear market case was caused by OPEC’s oil embargo, which completely froze the U.S. economy and led to a sharp recession. A repeat of that historical scenario is unlikely today. The U.S. is increasingly energy independent, which means that the U.S. economy and stock market isn’t particularly beholden to foreign interests.
All the other cases are bullish.
Click here for more market studies.

4 comments add yours

  1. Hi Troy, have you looked at which of the yield inversion events is a more accurate leading indicator of a recession/downturn – (1) 2yr v 10yr or (2) 3 mo v 10yr? Has there been a case where the 2yr/10yr inverted but the 3mo/10yr did not? There’s been an uptick in articles and discussion about a 2yr inversion, but not so much with the 3mo.

    • Hi Nick,
      Yes, I actually started out with the 10 year vs 2 year (which is the more popular one). But overall, the 10 year minus 3 month gives you a more timely SELL signal. The 10 year vs 2 year tends to invert a little too early.

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