Does Current Yield Curve Inversion Signal Crash For Stocks?

Our goal is to present the best bullish and bearish cases for markets and the economy. We try to improve your and our own understanding of markets to make the smartest decisions. We write articles to counter silly arguments made by pundits, such as claiming stocks fell on Tuesday because Wednesday was a holiday. Following that logic, stocks should crash every Friday.

In this article, we will present some of the bullish points as to why the latest yield curve inversion doesn’t pose a near term threat to stocks. If you expected this cycle to be average, you would have overestimated the average annual GDP growth rate and underestimated the length of this expansion. Following that logic, don’t assume the stock market and economy will follow the average period following yield curve inversions. Furthermore, the curve could be wrong as it doesn’t have as good of a track record in international economies such as Japan.

Some Yield Curve Inversions Are Irrelevant

The chart below suggests that yield curve inversions such as when the 2 and 3 year bond yields recently moved higher than the 5 year bond yield are irrelevant. It’s common to see many parts of the curve invert at once because the differences compress when it flattens. As of early December, most of the curve isn’t inverted, which is what matters.

Percentage Of The Curve Inverted

 

Source: Twitter @Solomon_Slate

The chart above shows when only part of the curve inverts, there’s a chance the inversion will give a false positive recession warning. Look for 80% of the curve to invert before expecting a recession. This doesn’t mean we should discount the latest inversion entirely. When some parts of the curve invert, the rest can follow very quickly. Whether you’re on the bullish or bearish side of the debate, you need to bring more to your analysis than just looking at the yield curve.

ISM & PE Multiples

We follow the ISM closely because it has been a good predictor of stock returns. The two charts below map stock returns based on the ISM manufacturing index and changes to the market’s PE multiple.

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