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History shows inverted yield curve is no death knell for S&P 500

The hand wringing among stock investors over an inverted yield curve is overblown, if history is any guide.

So says Canaccord Genuity’s strategist Tony Dwyer, who has studied equity market performance after the payout of long-term Treasurys fell below that of short-dated government debt. Such inversions have occurred seven times since the early 1950s and all but one preceded equity gains. Specifically, the S&P 500 rose a median 19 months before peaking after an inversion, with returns reaching 21%.

bearded stock exchange trader Bloomberg News
A trader works on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Monday, March 13, 2017. U.S. stocks held steady as they kicked off a week dominated by central-bank updates including the Federal Reserve's rate decision. Photographer: Michael Nagle/Bloomberg

The analysis is perhaps a wake-up call for many who sold equities this week after the difference in yields on 3- and 5-year notes dropped below zero for the first time since 2007. The negative showing was one culprit blamed for the S&P 500’s 3.2% plunge Wednesday as bears pointed to the bond market as flashing an ominous signal on the economy.

More importantly, according to Dwyer, the more commonly followed 2- to 10-year yield spread, which the firm monitors as a potential indicator of pending recessions, is still positive, albeit at 12 basis points, close to the smallest since 2007. The S&P 500 has proved to be able to shrug off most initial inversions because continued economic expansions, even at a slower pace, bode well for stocks.

“I’m not saying it’s not going to be a recession. I’m not saying it’s different this time. I’m saying it’s the same,” Dwyer said by phone. “You’re going into a recession, but it typically happens well after, with stocks much higher from the initial date of inversion,” he said. “History says you don’t want to be a seller here. You want to be a seller higher.”

Health category funds dominated the list, making up for well over half of the group’s assets.
December 5

While fears over an inverted yield curve may be overdone, the heated discussion of the topic reflected two pressing issues that are gripping the market: slowing growth and higher interest rates. And it’s not hard to see why investors got so hung up on negative narratives with the bull market in stocks approaching its 10th anniversary.

Investors can be forgiven for taking caution against a worst-case scenario now that strategists at firms including Goldman Sachs and Bank of America have recommended raising cash in anticipation of a lackluster 2019. A potential inverted yield curve is likely to lead to a mild bear market next year, BofA strategists Mary Ann Bartels and Andrew Shields wrote in a note this week.

Still, others say worries over an inversion are premature as economic data from manufacturing to initial jobless claims has shown solid growth. While economists see the economy losing some steam over the