What Happens After a Yield Curve Inversion?

By Modern Wealth Management

August 26, 2019

What Happens After a Yield Curve Inversion?

On August 14th, 2019, the Yield Curve between the 2-Year and 10-Year Treasury bond inverted for the first time since May 2007. This caused the stock market to sell-off, with the Dow Jones Industrial Average dropping more than 800 points. What happens after a Yield Curve Inversion? Why were the markets so spooked?

The answer is a 2/10-Year Yield Curve Inversion is viewed by many as one of the most reliable signs that a recession is on its way. A 2/10-Year Yield Curve Inversion has predicted the last 7 recessions, and 9 out of the previous 12. However, while it’s not if, but when the next recession comes, it’s probably not time to run for the hills just yet. While history may not repeat itself, it can give us clues as to what happens after a yield curve inversion; clues we may well want to pay attention to.

What Happens After a Yield Curve Inversion Historically

From a historical perspective, an Inverted Yield Curve is a leading indicator. What happens after a yield curve inversion is it lets us know a recession is coming. However, it doesn’t mark the beginning of a stock market decline. In fact, once the Yield Curve has inverted, after an initial drop, the stock market generally runs on to new highs just prior to the recession setting in.

According to this article from ZeroHedge, the average return in the stock market following a Yield Curve Inversion is 9.52%, and the median return is 11.9%. The worst stock market performance following an Inverted Yield Curve was 2.04% in 1965, and the best performance was 28.5% in 1989.

The average length of time between an Inversion and the beginning of a recession is 15.1 months. The shortest time between an Inverted Yield Curve and the start of a recession was 8.1 months in August 1959, and the longest was 23.3 months following the Inverted Yield Curve that occurred in December of 2005.

Stay Cautious, but Calm

What this all means is, it’s probably not time to run for the hills yet. In fact, just the opposite may be true. It’s not that we should be complacent, but let’s not overreact to this recent volatility. My father used to say, “This too shall pass,” and he was right. It always does. And, to be sure, this 10-Year bull market shall pass too but probably not as soon as the financial media may lead you to believe.

As ever, we remain vigilant in keeping you as safe as possible over the long-term; though short-term volatility is undoubtedly going to be with us for some time to come. So, buckle up, turn off the market news, and focus on what’s important.

You can learn more about the yield curve in our article What is Yield Curve Inversion? Also, don’t forget to check out our latest Monthly Economic Update with Dean Barber, Market Volatility and the Yield Spread. In a little more detail, Dean discusses what happens after a yield curve inversion and how he feels about the current market volatility. We provide a second opinion and will stress-test your portfolio for the future, schedule a complimentary consultation below, or give us a call anytime at 913-393-1000.

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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.