Key Points

  • Equity markets have stabilized and remain within their broad range established over the past six months, but risks remain.

  • Manufacturing sentiment and activity continue to be weak, but that malaise has not yet bled into the larger consumer segment of the economy.

“I’m not afraid of storms, for I’m learning how to sail my ship.”
― Louisa May Alcott

The Clouds

The theme to our 2019 outlook was “be prepared” and we continue to see some clouds forming on the horizon.

Aside from trade/tariff volleys (if only we could move aside from trade news), the latest concern has been the inversion of the 10-year/2-year Treasury yield curve. As you can see below—similar to the 10-year/3-month curve that first inverted in March—the 10-year/2-year inversion has preceded every recession since the 1960s. However, there were two periods—in 1966 and 1998—when the yield curve inverted, but a recession remained a fair distance away.

10s-2s curve inverts

Recessions are inevitable and occur at the end of every economic cycle, so the U.S. economy is sure to have one. The unknown factor is the amount of time until it arrives, as the lead time from inversion until recession is highly variable:

  • The median span from an inversion in the 10y-3m curve and recessions historically was 12 months—with a range of five to 23 months.
  • The median S&P 500 performance during those spans was 4.2%—with a range of -16.6% to +22.8%.
  • The median span from an inversion in the 10y-2y curve and recessions historically was 17 months—with a range of 10 to 24 months.
  • The median S&P 500 performance during those spans was 4.4%—with a range of -12.0% to +30.0%.
  • Of course, past performance is no guarantee of future results, but importantly, the ranges show that there is little consistency historically in terms of recessions’ timing or stock market performance in the aftermath of inversions in the yield curve.

Various pundits have dismissed both yield curves’ inversions this time around, citing the unique circumstance around why the curve inverted this year. Being mindful of the daring use of the phrase “it’s different this time,” the reality is that every cycle is unique in nature. This time around, the phenomenon of $17 trillion of negative-yielding global debt (Wall Street Journal) is certainly novel—and has undoubtedly led to significant safe-haven/higher-yielding purchases of longer-term Treasury securities. As such, unlike most past episodes, the curve inverted this time because long yields fell below shorter-term yields vs. the Fed raising short-term rates above long-term yields. That said, an inverted yield curve, when persistent (and regardless of why/how it inverted), does crimp or eliminate the spread banks can earn by borrowing short and lending long—typically constraining credit availability, a common precursor to recessions.