Forward Returns Following A US102 Year Inversion

A look at how markets have performed following a US 10-2 yield curve inversion.

Unless you’ve been living under a rock, you may have heard a thing or two about the yield curve inverting in the news recently. In fact, you probably heard the several months lead-up to its potential too. Well, the yield curve has indeed inverted and sparked a fresh round of calls for a recession some time over the next 20 or so months (although estimates do vary in the timing).

As my colleague Joe Perry pointed out, regardless of whether a session materialises, equites have tended to bounce after such a signal. So, we’ll start with backing this up with a chart and see how other markets reacted following an inverted 10-2 yr yield curve.

Basically, an inverted yield curve has been positive for stocks overall
Median prices (ie typically) trend higher between 0-3 months after the yield curve inverted
Interestingly, on average the S&P500 was trading lower from 1-2 weeks out but, overall trends higher as it moves towards +3 months
With exception to the next day, average returns were positive over 50% of time

Somewhat surprisingly, WTI appears to show an even clearer trend than the S&P500
Average returns are positive (and over 50% of the time) around the first week, and become increasingly more bullish from 1 to 3 months after the inversion
It’s good to see average and median prices moving in lockstep, as it suggests the average returns are not powered by a few outliers

Another surprise, this time from gold, where a trend is hard to decipher
My expectations of a bullish trend have not been met
With median prices negative one month after, with the average positive, there’s clearly some outliers here to push the average up
Overall, gold’s pattern it too difficult to decipher to read much into it, surrounding inversions over this time horizon

Taking a broader look at commodities (using the CRB Core Commodity Index) shows that, overall, commodities come under pressure
That said, the trend is clearer on bearish average forward returns (outliers weigh it down) whilst median (ie typical) prices meander between bullish and bearish
Whilst we could argue broad commodity prices are bearish on average, the trend is not as compelling as seen on S&P500 or WTI

Copper prices tend to come under pressure for the month following the yield curve inversion
Median prices remain bearish for up to 3-month, yet peak around 6 weeks after the signal
Average returns are notable bullish 3 month out, although likely fueled by outliers as median remains bearish
On average, forward returns are bearish over 50% of the time from T+3 onwards

It appears that emerging markets (EEM EFT) love a good yield curve inversion.
What’s compelling about this chart is how average and forward returns are clearly trending higher (and increasingly so towards +3 months) whilst also over 50% of the time (excluding the day of the signal
However… it should also be noted that the technicals for EEM ETF do not currently align with this bullish view, so we’d urge to wait for a basing pattern to be confirmed before assuming a low might be in place
And this data set is only form 2005 (so a smaller sample size means its statistical significance may be less reliable)

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