Inversion of the curve = recession? This is how the markets are reacting

In the, I talked about two phenomena that affect the current market dynamics, namely high inflation and curve inversion. Regarding the first aspect, we have already discussed in the past, now we see the second aspect, namely the inversion of the curve.

Technically referred to as an inversion of the yield curve, when the yield on the short-term US government bond (2 years or 3 months) exceeds the yield on the long-term US government bond (10 years) .

In the image above we see how lately this has happened in 2019 and this year. The argument made by many people is that usually when something like this happens, the economy eventually goes into a recession. How much truth is there in this statement? Let’s see…

I have “enlarged” (see below) the image seen previously, going back to 1975, so that we can see that in this period 7 reversals occurred (when the blue line ends below the zero level).

Source: FRED

As we can see, periods of recession (grey lines) are indeed always followed by some time. So we could answer “YES” to the question above, but let’s be more specific.

Source CharlieBilello

The periods highlighted in gray are actually repeated in the table above as well, i.e. the last 6 recessions (the week at this point should arrive in a few months) have always occurred, and this 19 months (on average) after the inversion of the curve.

This means that if the reversal occurred in March 2022, one could expect a period of recession towards the end of 2023.

But as always, on the investors’ side, I wonder… What about the markets in all of this? How have periods of recession affected them?

To do this, consider the example of the index , shown below. I have highlighted with arrows the periods corresponding to the different recessions, and in the table below, I have indicated their performance:

Source: Investing.com

Results of S&P 500 recession periods:

Source: author

It would seem (I use the conditional) that it is not interesting to invest during a recession, since the average performance is negative by 5%.

But as always, we have to go a little further, because there are at least 3 important considerations to take into account:

  1. In the results of the table above, dividends (which average 3% per year) are NOT taken into account. In fact, I have drawn up a comparison below between the normal S&P 500 index (without dividends, blue line) and the same “total return” index (thus including dividends). If we take this variable into account, the results will be much better.
  2. What did the markets do just before and just after recessions? If we widen our time horizon, we can immediately see that the results are very positive (you would practically have to have very bad timing to invest when the economy enters a recession and to come out of it as soon as it ends).
  3. If we look at the table above, we can see that the destabilizing “event” that pushed performance into the negative is mainly linked to the subprime crisis, with a negative performance of more than 37%. This is a historically rare fact, without which the figures would be much more positive.
Source: Investing.com

Findings

In a previous analysis, I said that it is ALWAYS a good time to invest, provided you do it with intelligence, knowledge of history, management of your emotions and adequate patience. With these 4 elements in our favour, any recession or market downturn we face will be largely surmountable and could even turn into a new opportunity not to be wasted.

Until next time !

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“This article has been prepared for informational purposes only; it does not constitute a solicitation, offer, investment advice or recommendation and, as such, it is not intended to encourage the purchase of assets in any way. I would like to remind you that any type of asset, evaluated from several points of view, is very risky and therefore any investment decision and the risk associated with it are the responsibility of the responsibility of the investor.

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