Is A Yield Curve Inversion Bad For Stock Returns?

Many investors see yield curve inversions—when short-term bond yields exceed long-term yields—as foreboding. Do they signal a stock market downturn? Data from the US and other major economies show yield curve inversions have not historically predicted equity market downturns. As markets incorporate news and events around the world, bond yields change, which causes yield curves to change. Historically, the US Treasury yield curve has generally been upward-sloping; however, during several periods, the curve inverted. What can we learn from these examples?

The US Market

The inversion prior to the 2008 financial crisis is an interesting case study. As shown in Exhibit 1, the US yield curve inverted in December 2005, which was followed by a positive 12-month return for the S&P 500 Index. The yield curve’s slope shifted to positive again in June 2007, well prior to the equity market’s major downturn from October 2007 through February 2009.

Investors who interpreted the inversion as a sign of an imminent market decline and pulled out of stocks could have missed out on subsequent equity market gains. And if those same investors had bought back into stocks when the yield curve’s slope became positive, they would have been exposed to the market downturn that followed.

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Robert J. Pyle, CFP®, CFA, AEP® founded Diversified Asset Management, Inc., in 1996 to provide personalized, comprehensive wealth management services to successful individuals, families, single women, and business owners. His specialty is addressing the complex financial needs of self-employed professionals, corporate executives, and small-business owners. Our disclosure can be found here. The views, opinion, information, and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc. Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting, or tax advice.