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Yield Curve Inversions And Future Stock Returns

Published Wed, 15 May 2019 09:37:55 -0400 on Seeking Alpha

During the tumult of global equity markets last week, brought about by rising trade tensions, a key part of the Treasury yield curve briefly inverted once again. With a flight-to-quality bid into longer duration Treasury securities, the yield on the ten-year Treasury was briefly lower than the yield on Treasury securities maturing in three months. Changes in the slope of the yield curve are driven by market expectations about the business cycle. Stronger economic growth has the tendency to increase inflation and inflation expectations, driving yields higher and bond prices down to compensate investors for the lower "real" yields. Conversely, when economic growth is weakening, you can see the yield curve flatten or even invert. Trade tensions and their impact on future growth led in part to a decline in longer-term Treasury yields.
Why is the shape of the yield curve important to Seeking Alpha readers? As graphed below, all seven domestic economic recessions in the U.S. in the last 50 years have been preceded by an inverted yield curve. There were no economic recessions in the U.S. in this 50-year plus period that were not preceded by an inverted yield curve. Understanding the information about the shape of the yield curve should factor into your portfolio construction.
An inverting yield curve is a sign that participants in a large global market - the market for U.S. Treasuries - expect lower future rates. The Expectation Hypothesis of the yield curve states that the term... Read more