Lessons from yield curve history

Stocks were under pressure for much of August as U.S.-China trade tensions escalated, with Washington and Beijing announcing escalating rounds of tariff increases. Worries over the economic outlook rose, highlighted by a Treasury rally that sank yields and resulted in an inversion of the main measure of the U.S. yield curve, with the 10-year yield falling below the 2-year rate—a phenomenon viewed as an often reliable recession indicator.

Markets tend to keep moving higher immediately following a yield curve inversion. Since 1978, the S&P 500 has risen an average of 13% from the first time the spread inverts on a closing basis to the beginning of a recession, according to Dow Jones. Since 1956, past recessions have started on average around 15 months after an inversion of the 2-year and 10-year yields. Of course, past performance cannot guarantee future returns.

Even if the yield curve means a recession is on the way, that shouldn’t necessarily be a red flag for investors.

Contrary to what you might think, stocks actually rose during half of the last 14 recessions, and they were positive in 11 out of the 14 years leading up to a recession. The stock market was down a year later only three times following a recession. In general, stocks tend to perform about average in the year leading up to a recession, below average during a recession, and above average in the one, three, and five year periods following the end of a recession.

Click here for a table of stock market returns before, during, and after recessions.