Beware An Inverted Yield Curve

In all five recessions, the yield curve inverted ahead of the S&P 500 peak. The average amount of time between when the yield curve first inverts to when the S&P 500 peaks is 504 days, or about 16 months. The average price gain for the S&P 500 during those five periods is 24.5 percent.

While “beware an inverted yield curve,” is a strong battle cry worth respecting, it shouldn’t be cause for investors to immediately exit the markets as soon as it happens. Not only did the S&P 500 rise each time after the yield curve inverted as shown above, in some instances it rose by a significant amount. Bear in mind the gains noted above do not take into account dividends, so the total return for the S&P 500 in each of those time periods is actually greater than the values listed. This makes the case for staying invested after the yield curve first inverts that much more poignant. While an inverted yield curve is cause for concern, it shouldn’t be a cause to abandon the stock market and run for the hills. What it does call for is caution and demands investors pay close attention to changing winds in the marketplace.

Following the yield curve is but one of many important economic indicators investors should reference to gauge the health of the stock market and economy. An investment strategy should not be based on this or any other indicator alone. What watching the yield curve can do for investors, however, is inform tactical and asset allocation decisions. Knowing how past yield curve inversions, recessions and market actions have played out can provide insights on how to invest for the next yield curve inversion.

The prudent and germane advice on the yield curve bestowed forever upon me those many years ago have been echoing in my mind as the yield curve marches toward inversion. While that advice holds merit all its own, I’d like to add my own twist, which is:

“Beware an inverted yield curve! It can save you money!”

Michael J. Graziano, CMT, CRPC, is managing director at Graziano Budny Wealth Management Group.