Historic Bear Market Signal Flashes
A rare economic milestone was just triggered, one that has preceded a bear market 12 out of the last 13 times it has occurred over the past 85 years. This historical data point is adding to a growing sense of caution among institutional investors, who are now weighing the possibility of a more severe downturn.
The signal referenced is most likely an inversion of the U.S. Treasury yield curve, a historically reliable predictor of economic downturns. An inverted yield curve occurs when short-term government bonds offer higher interest rates than long-term bonds, suggesting investor pessimism about the economy's future. This indicator was pioneered by Duke University finance professor Campbell Harvey in the 1980s. His research focused on the spread between the 10-year and 3-month Treasury yields, and it has correctly predicted the last eight U.S. recessions without any false signals. An inversion signals that investors expect long-term growth to be weak, prompting them to buy long-term bonds and drive their yields down. It also negatively impacts the banking sector, as banks typically profit from borrowing at lower short-term rates and lending at higher long-term rates. Historically, a recession has followed a yield curve inversion within six to 23 months. While not every bear market is accompanied by a recession, nine of the last 13 bear markets since World War II have coincided with one. Another frequently watched pairing is the 2-year and 10-year Treasury note yields. While different parts of the yield curve can invert at different times, a sustained inversion across multiple segments is seen by many economists as a strong warning. The Federal Reserve's interest rate policies are a key factor in these inversions. A series of aggressive short-term rate hikes aimed at controlling inflation can often be the trigger that inverts the curve, an event that has preceded 10 of the last 13 Fed tightening cycles ending in a recession.
