What The Yield Curve Is Saying About The Stock Market Rally

The SPDR S&P 500 ETF Trust (SPY) is up 31.8% since March 23, but many investors are skeptical of the rally given the ongoing global COVID-19 pandemic. Investors looking to confirm the recent rally has legs should look to the yield curve, according to Sevens Report Research’s Tom Essaye.

Essaye said the peaks of the last two bull markets in 2000 and 2007 were both marked by an investigation of the two-year and 10-year Treasury yields followed by a sharp steepening. Those two instances are marked in the chart below.

Essaye said the good news for stock buyers is that the recent steepening in the yield curve has been moderate and relatively slow-paced. “That implies, for now, that the rally is potentially more sustainable in the near and medium term,” Essaye wrote in a report.

Levels to Watch

In the longer term, Essaye said if the yield spread remains where it is now at around 0.5%, the stock market could continue to rally in the long term in a similar fashion to how it did in 1998.

What the yield curve does from here could determine whether the recent rally is the beginning of a return to all-time highs or simply a bear market bounce.

“If we get a ’07/’08 type of quick acceleration higher in the 10s-2s spread (towards and well beyond 1%), that implies trouble for equities over the coming quarters,” Essaye wrote.

Benzinga's Take

When the market is as volatile as it has been in 2020, it can be difficult to maintain a longer-term perspective on investing. After two months of higher stock prices, it may seem like stocks have clear skies ahead.

Until the S&P 500 is making new highs, there’s still a chance that the longer-term market trend is bearish.