Recession Warning: The Bond Yield Curve Inversion

Well, it’s 2023, and it appears we have a lot more market downside to endure.

If you’re keeping a close eye on the stock market, you may have heard the term “yield curve inversion” being tossed around lately. But what exactly does it mean, and why does it matter?

A yield curve is like a line graph that shows how much interest you would earn if you invested in different types of bonds with different maturities. Long-term bonds, such as 10-year bonds, typically pay higher interest rates than short-term bonds, such as 2-year bonds, to compensate investors for tying up their money for a longer period.
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A yield curve inversion happens when this relationship is flipped, and the interest rates on long-term bonds, such as the 10-year bond, become lower than those on short-term bonds. This means that investors are more worried about the short-term economic outlook and are willing to accept lower returns on longer-term bonds to protect their money from potential losses in the future.

The inversion of the yield curve is seen as a warning sign of a highly potential economic downturn, as it suggests that investors are pessimistic about the future and are seeking safer investments.
This is a significant indicator of a likely economic downturn. In fact, every time this inversion has occurred since 1980, it has been followed by a recession, making it a reliable predictor of an economic downturn.

However, it’s important to note that the timing and duration of these recessions can vary. For example, the recession that followed the 2006 yield curve inversion was not immediate and lasted from December 2007 to June 2009.

IMPORTANT: See the chart below. Each vertical red line indicates the end of a bond-yield inversion. Anytime this occurs, a recession always follows. The effect on the market is severe. Historical data shows the average market drop during the past six inversion crashes was a whopping -28.4% for the S&P and -40.4% for the Nasdaq. This can be a scary prospect for investors, especially those who are new to the stock market or who may not have experienced a major multi-year market dip.

Tradingview chart: The teal line is the SPX (S&P-500) price and the thin blue line is the bond yield curve between the 10-year and 2-year bonds. Anytime the bond yield curve line dips below the thick red horizontal lines, a rare bond yield inversion occurs and should be noted.
 
We’re currently in a historically deep bond yield inversion. The real concern is when the inversion comes to an end. The bond yield curve has turned upward and heading towards ending the inversion. The question is how long it will take for the recession to sink in thereafter and for the markets to take their next leg downward.

Our estimate is that the drop could start as early at Q4 of 2023 or could hold off to Q1 or even Q2 of 2024.

Regardless, another 30-40% market drop, and the expected double-digit unemployment will be a shock to the economic system.

It’s important to remember that there are ways to potentially mitigate risk during times of market turbulence. For example, some investors may choose to diversify their portfolios or invest in sectors that tend to be less affected by economic downturns.

Another strategy is to learn how to trade the markets effectively. While trading the markets carries risk, having a solid understanding of how they work and knowing how to read market trends can potentially help investors make more informed decisions and minimize their risk.

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The Tradingview chart above is a monthly chart of the SPY (S&P-500 ETF). It’s in a bearish rising wedge trend reversal pattern and showing a bearish flag set up too. Furthermore, the Grok ROC algorithm, bottom of the chart, is about to plot a SELL signal. The many bearish technical signals confirm what the bond yield inversion is warning. Unfortunately, we’re set up to experience a lot of upcoming economic pain.

We do not have to be fearful. As an owner of an education company that specializes in teaching stock trading, I firmly believe that education is the key to success in the stock market. By teaching our students how to read market trends, identify opportunities, and manage risk, we are equipping them with the tools they need to succeed in any market condition.