The ins and outs of past yield curve inversions and stock performance
Author: Stephen Duench
February 6, 2019
It’s no surprise that investors have grown increasingly worried about the U.S. Treasury yield curve inverting. After all, as history shows, recessions have a habit of happening on the heels of an inversion — especially when that inversion involves the spread between the two-year and 10-year note maturity.
Even so, some investors may be overestimating the potential negative impact that an inverted yield curve can have on stock market returns. Based on our research dating back to 1977 of ten yield spreads along the U.S. Treasury curve, S&P 500 Index returns remained, on average, positive in the year leading into an inversion, as well as the year following.
The index’s performance does weaken the closer time gets to the inversion date. But the inverted spreads that have coincided with the worst returns have tended to be those involving the three-month Treasury yield and longer-term maturities. Interestingly, an inversion of the two-year and five-year yield has corresponded to some of the better intermediate returns found in our research, while the recession-whispering two-year to 10-year inversion has generally occurred without pushing S&P 500 performance into the red.
Source: AGFiQ with data from Bloomberg LP as of December 11, 2018. Performance has been colour-ranked for each time frame (column) with darkest blue representing best return and darkest orange representing worst return.
The magnitude of previous inversions seemed to play a role in past stock returns as well. The steeper it was, the worse the performance and vice versa. And not surprisingly, forward return profiles were better when fewer spreads along the curve inverted. In fact, it’s only when there were seven or more spread inversions that future S&P 500 performance turned negative and, even then, negative returns were relatively muted.
Source: AGFiQ with data from Bloomberg LP as of December 11, 2018. Performance has been colour-ranked for each time frame (column) with darkest blue representing best return and darkest orange representing worst return.
Further to this point, when there were fewer inversions, S&P 500 returns tended to weaken more substantially right before these spreads invert, but then strengthen more aggressively afterwards.
None of this is to suggest that future inversions of the U.S. Treasury curve will lead to similar outcomes for the S&P 500 (or other global equity indexes for that matter). It may, however, provide important perspective at a time of growing economic uncertainty and increasingly volatile markets.
AGFiQ’s Stephen Duench is a vice president and portfolio manager with Highstreet Asset Management Inc. He is a regular contributor to the AGF Perspectives blog.
AGFiQ Asset Management (AGFiQ) is a collaboration of investment professionals from Highstreet Asset Management Inc. (HSAM), a Canadian registered portfolio manager, and of FFCM, LLC (FFCM), a U.S. registered adviser. This collaboration makes up the quantitative investment team.
Commentaries contained herein are provided as a general source of information based on information available as of January 31, 2019 and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Investors are expected to obtain professional investment advice.
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.
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Written by
Stephen Duench, CFA®
Vice-President and Portfolio Manager
AGF Investments Inc.
