Inverted yield are pretty prescient when in comes to recession calls. But are the markets smart enough to read the tea leaves? Read on.
That covers the past three U.S. recessions, excluding the COVID-19-induced contraction of 2020, which I have omitted since it had nothing to do with macroeconomic factors, monetary policy, etc.But the yield curve’s impeccable record of predicting recessions has not been matched by its market-timing abilities. The S&P 500 index rose 24.1 per cent in the two years following the Treasury curve inverting at the beginning of 1989, dropped 21.5 per cent after March 2000 and fell 9.
The trillion-dollar question is not whether the market is smart, but whether it is smart enough. Do prices bake in a sufficient amount of bad news ahead of time so that they avoid further losses following the onset of recessions? Or do they lack sufficient pessimism to avoid this fate? Frustratingly, the answer depends on the recession.
The happy ending for stocks following the curve inversion of 1989 and the market declines following the inversions of early 2000 and late 2006 were preceded by very different equity market valuations.The cyclically adjusted price-earnings ratio of the S&P 500 when the Treasury curve inverted in early 1989 was 15.1, 34.3 per cent below its average of 23 since 1980.
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Today’s special: An inverted yield curve with a side order of (possible) recessionInverted yield are pretty prescient when in comes to recession calls. But are the markets smart enough to read the tea leaves? Read on.
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