The Truth About Yield Curve Inversions
The party’s over, folks… You don’t have to go home, but you can’t stay here.
That’s at least what markets told investors Wednesday as stocks once again crashed into the red.
A major recession warning manifested as the yield on the 10-year Treasury yield fell below the 2-year.
This rare market phenomenon is known as an inverted yield curve, and for all intents and purposes it’s a harbinger of doom.
Good, because I need your attention.
Yield inversions are not an exact science, but they are telling data that an inversion does in fact indicate a pending bear market, and possible recession.
In fact, an inverted yield curve has preceded the last two bear markets, as you can see below:
The yield curve inverted prior to recessions in 1981, 1991, 2001 and two years before the 2008–09 financial crisis and Great Recession. So you definitely want to keep tabs on this indicator.
But… and this is a BIG BUT…
There’s a lot more to the yield curve inversion that the mainstream media are not telling you.
Here’s the Truth About Yield Curve Inversions
The reality is most yield curves of various maturities have inverted at one time or another in recent months.
But for the sake of simplicity, let’s focus on the spread between 10-year and 2-year Treasuries.
As you can see in the chart above, this yield spread has indeed inverted.
But the inversion is a warning flag. It’s the un-inversion of the yield curve, when it returns to normal again after a prolonged inversion, that you must watch out for.
And stocks very often post their best gains AFTER a yield curve inversion. The chart below highlights this trend perfectly:
Pulled from a JPMorgan research note earlier this year, the chart clearly shows robust gains for at least 24 months after a yield curve inversion.
That’s the real silver lining to this story.
And in JP’s note, analysts write: “Performance of the stock market after the onset of inversion tends to be extraordinarily strong… The pace of market gains tends to be above average for up to about 30 months after first inversion.”
Meaning while inversions often eventually do lead to an economic recession, there’s often a very big lag time — up to 30 months before it actually happens!
Most Times Stocks Surge Too!
The median gain for the S&P 500 after the yield curve inverts is over 10%. And historically there are plenty of examples of much bigger returns:
- In 1978 the yield curve inverted in October and the S&P gained nearly 50% over the next two years
- And in 1998 the yield curve went negative in September and — get this — the Nasdaq soared 226.9% over the next 1½ years while the S&P surged nearly 50% higher!
- Even after the most recent inversion in 2006, the S&P rallied 20% higher over the next two years.
Yes, investors got a big warning sign today. But it’s a warning that doom is on the way, not actually here.
And before the doom and gloom actually hit markets, we have a great opportunity to ride the meltup for big money.
Now’s the perfect time to make the necessary moves to protect yourself.
There’s no better way to do this than securing a basket of high-quality dividend stocks.
For starters, while the meltup phase occurs, you’ll reap handsome rewards by staying invested in quality companies.
And when the market does finally roll over, you’ll already have an added layer of protection in the form of quarterly dividend payments you can use to pad your income during the next recession.
Here’s to growing your wealth,
Chief Income Expert