Should Investors Fear The Inverted Yield Curve?
August 22, 2019

Should Investors Fear The Inverted Yield Curve?

Plenty of investors focus on economic news. They worry about where stocks are headed. They want a quick heads-up so they can bob or weave in case stocks hit the skids. But investors usually make more money if they do three things:

  1. They invest every month.
  2. They build diversified portfolios of low-cost index funds
  3. They ignore investment news.

Warren Buffett says investing is simple, but it isn’t easy. The toughest part might be ignoring economic news.

Consider the latest: Many are worried about the inverted yield curve. On Wednesday, August 14th, the interest yield on 2-year U.S. treasury bonds inched higher than the interest yield on 10-year treasury bonds. That rarely happens. Usually, the yield on longer-term bonds is higher than the yield on short-term bonds. After all, if people are going to park their money for a long period, they want to be compensated more for doing so.

Now here’s the part that gives investors chills. In 2018, Michael D. Bauer and Thomas M. Mertens published, Economic Forecasts with the Yield Curve. They wrote that when bond yield curves invert, a recession is on its way.

The Washington Post recently published the following chart.

An Inverted Yeild Curve Usually Signals Trouble

The red circles indicate inverted yield curves. The shaded regions represent recessions. I don’t doubt the research. But investors should be asking one important thing: If there’s a recession, will stocks hit the skids? After all, for many investors, that question matters most.

In 2006, Richard G. Anderson wrote, Yield Curve Inversions and Cyclical Peaks for The Federal Reserve Bank’s Economic Synopsis. He listed several dates from which inverted bond yields began. Here’s every date since 1973.

  • June 1973
  • November 1978
  • October 1980
  • June 1989
  • July 2000
  • January 2006

I wanted to see if U.S. stocks struggled after bond yields inverted. The financial news media might not like this...because they love scary headlines. But this might calm your nerves.

On average, after bond yields inverted, U.S. stocks made profits over the following 1-year, 3-year, 5-year, 10-year and 20-year periods.

How U.S. Stocks Performed After Bond Yields Inverted

1-Year Average Annual Return 3-Year Compound Average Annual Return 5-Year Compound Average Annual Return 10-Year Compound Average Annual Return 20-Year Year Compound Average Annual Return
+5.27% +0.36% +9.46% +12.0% +12.01%

If you’re trying to predict how stocks will perform, bond yields and tealeaves simply won’t work. But sadly, some investors will always try to see a pattern. For example, notice the table above. U.S. stocks averaged just 0.36 percent per year over the 3 years after an inverted bond yield curve began. Such investors might say, “Those returns look bad. There’s an inverted bond yield now, so I’ll sell my stocks for the next three years.” But if they do, that could be a big mistake.

An inverted bond yield occurred in June 1973. Over the following 3 years, U.S. stocks averaged a compound annual return of 4.23 percent.

The next inverted bond yield period began November 1978. Over the next 3 years, U.S. stocks averaged a compound annual return of 19.7 percent.

The following inverted bond yield occurred in October 1980. Jumping out of stocks would have been expensive. After all, U.S. stocks averaged a compound annual return of 15.95 percent over the next 3 years.

Almost ten years later (June 1989) bond yields inverted once again. Over the next 3 years, stocks averaged a compound annual return of 10.5 percent.

I’m not saying that stocks won’t fall. On average, stocks drop about 1 out of every 3 years. But predictable patterns don’t exist. Nobody knows when the next drop is coming. That’s why it’s best to add money every month to a low-cost portfolio of index funds. Even if you’re retired, single year returns (even decade-long returns) shouldn’t matter much.

If you want to make money, ignore forecasts. Over time, forecasts tempt people into doing silly things. Intelligent investing really is simple. Just keep your head in the sand and stay on course.

Growth Of U.S. Stocks
Measuring $10,000 Invested At The Beginning Month Of Inverted Yield Curves

Inverted Yield Curve Began
June 1973 1 Year Later 3 Years Later 5 Years Later 10 Years Later 20 Years Later
$8,383 $11,326 $12,219 $30,153 $99,374
November 1978 1 Year Later 3 Years Later 5 Years Later 10 Years Later 20 Years Later
$12,723 $17,170 $24,919 $44,740 $218,239
October 1980 1 Year Later 3 Years Later 5 Years Later 10 Years Later 20 Years Later
$10,741 $15,589 $19,861 $33,366 $158,102
June 1989 1 Year Later 3 Years Later 5 Years Later 10 Years Later 20 Years Later
$11,205 $13,542 $15,770 $48,951 $42,770
July 2000 1 Year Later 3 Years Later 5 Years Later 10 Years Later 19 Years Later*
$8,347 $7,318 $9,727 $9,859 $31,460
Jan 2006 1 Year Later 3 Years Later 5 Years Later 10 Years Later 13.53 Years Later*
$11,768 $7,039 $11,814 $19,247 $31,238

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This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.

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