A popular indicator is the 10 Year Treasury yield less the
Two Year Yield. When the number is
positive or upward sloping, that is typically indicative of a growing
economy. The short version is that the
Fed heavily influences the short-end of the curve, so when investors are
confident about the economy they sell the long-bond pushing the yield up.
Now the Fed can and will, as evident by quantitative easing
(the Fed buying longer dated bonds), control the long-end too. Thus, even though we have an upward sloping
curve now there is still some heavy Fed influence as they are keeping
short-term rates very low. Further, the
drawing down of quantitative easing (no longer buying longer dated bonds) expected
Q1 next year should push up the long-end of the yield curve.
Still, even with that caveat I found the chart below pretty
fascinating. The blue line is the 10
Year yield less the 2 Year yield and the red line is the S&P 500.
A few things stick out:
- A negative sloping yield curve has ALWAYS led to a recession. There all no false positives.
- We have never had a recession since 1976 (from when the data was available) where the yield curve did NOT turn negative beforehand.
- The last two major markets tops in 2000 and 2007 coincided with a negative yield curve.
- We don’t have anything close to a negative curve now. In fact, the slope is moving higher.
While the sample size is small and everything works until it
doesn't, it bares extremely well for the economy. This has important
stock market implications. I have noted
before that even if earnings lag (say the economy is weaker than expected
or the record high profit margins come down) we can still have multiple
expansion to push the market higher given short-term valuations are not at
extreme levels. That isn't to say the
market can’t or won’t have a hiccup or pullback around 20% or so, just that a
larger bottom doesn't appear to be in the cards unless that 10-2 indicator
reverses.
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Inc. or Lincoln Investment. The
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