If you were to Google ‘yield curve inversion’ you would find many recent articles written about what this means and the possible implications for future stock returns. Some of the headlines include:
“The Yield Curve Inverted in 2022, Here’s Why That Spooks Markets”
“Treasury Yield Curve Isn’t Signal to Sell Stocks”
“The Yield Curve Should Alert Us to Possible Recession in 2023”
Simply put, a yield curve inversion is a point in time when rates for some longer-term maturities, are lower when compared to yields of shorter terms of equal quality. This is notable, as it seems counter intuitive to “lock” money up for a longer period in return for a lower yield. For instance, if you walk into a bank, you will generally expect a 5-year CD to have a higher yield than a 1-year CD but that is not the case with an inverted yield curve. Instead of having to parse through the volume of articles to find out what this could mean for the markets, you can read what the research shows here -> The Flat-Out Truth. For those that want to skip to the ending, a recently published research paper by Eugene Fama & Kenneth French concluded “We find no evidence that yield curve inversions can help investors avoid poor stock returns.”*
The yield curve inversion is an interesting phenomenon for investors to talk about but as a predictor of future market returns, the evidence does not support its ability to accurately forecast returns. Even if the yield curve was able to predict a recession or stock market decline you will still be left with predicting exactly when this will occur, the magnitude of stock price correction or severity of recession, and what the Federal Reserve will be doing in response. This insurmountable task of trying to predict all these occurrences makes a yield curve inversion notable but not necessarily a credible signal to act on. If you have any questions with this material let us know, and as always, thank you for the trust you place in our team.