September 09, 2022: Is this the countdown to end of the bull market?
The yield curve is a plot of the yields on all Treasury maturities ranging from one-month bills to 30-year bonds. A normal upward slope indicates that bond investors expect to be compensated more for taking on the added risk of owning bonds with longer maturities. On the other hand, an inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality.
The U.S. Yield Curve has been inverted since mid-July. The importance of this information is the curve has inverted before each of the recessions over the past 63 years. Whenever the curve has been inverted for 6 weeks or longer, as it has now, a recession and a market downturn have developed (Chart 1).
Not all inverted yield curves produce the same results. Of the past 7 recessions, most were long and deep (1981-1983, 2001-2002, and 2008-2009). Only the recessions in 1980, 1990, and 2020 were brief and shallow.
Economic recessions generally occur about 1 to 2 years after a prolonged yield inversion. However, the stock reacts faster. Downturns in the market (ie S&P 500) typically develop within 6-9 months of an inversion.
To finetune the arrival of the expected downturn, we use moving averages (Chart 2). The examples that we use are a 50-week and a 100-week. If the markets continue with their same path, the projected cross-over would occur in late Q4. These weekly downward cross-overs have marked the start of every bear market over the last 60 years. Chart 3 shows how the cross-over provided an early warning to the 2008-2009 bear market.
Bottom line: The U.S. Yield Curve has now been inverted for almost 8 weeks. This duration and action match other periods over the past decades where recessions have developed. Markets move before economics. By adding moving averages, we are able to finetune the projected crossover and the start of a potential bear market. If the market (ie S&P 500) continues on the same trend, the market is expected to advance to about 4,300 before turning down.