Summary
What is the yield curve and why is everyone suddenly talking about a recession? Was that it for the rally we saw at the end of March?
Inverted Yield Curve
The overwhelming majority of noise in financial markets this past week has revolved around the inverting of the yield curve. More specifically, the 2-year U.S. Treasury Note briefly rose above the 10-year U.S. Treasury Note for the first time since September 2019. Even though this has been plastered all over financial news pages this week, it isn’t something that has come out of nowhere. The yield curve has been flattening for over a year now. Nearly all of the people who are calling this a signal of an impending recession are leaving out a few incredibly important details. First, in all of the previous recessions, the spread between the 2-year and 10-year is just one of many warning signals and it is by no means the most important. For the professionals who follow these things closely and from a yield curve perspective, the 3-month, 10-year spread (currently 1.85%), is far more important and predictive. Second, in all of these past examples of this particular yield curve inverting before a recession, there has been a significant time delay between the inversion and the beginning of the recession. In fact, stocks actually tend to perform well in this type of environment. If we use the 2008 financial crisis as an example, this yield curve inverted in the Fall of 2005, and stocks peaked in October of…2007. It’s oftentimes costly to put too much weight on a single data point.
Market Outlook
For the most part, not much has changed over the past month. If I were to use one word to describe what we’re seeing across both indexes and individual sectors within those indexes, it would be “sideways.” After the surge of buying to close out the first quarter, stocks are consolidating as investors take profits along the way. This strong move is somewhat typical toward the end of a quarter and is often referred to as an “end of the quarter markup,” which typically fades in the following weeks. On a positive note, even though that rally is being sold, we are beginning to see improvements to market breadth in the NYSE for the first time all year. Specifically, we are seeing more stocks making new 52-week highs than stocks making 52-week lows. This doesn’t necessarily mean we are out of the woods yet, but it is another piece of evidence that market health is improving from where we were this time last month.
When markets are as turbulent as they have been, I find it helpful to pause and zoom out. While the most recent price action is being digested over the course of days or weeks, the price action from the breakout in 2020 to the peak in the first days of 2022 continues the same process of digesting those gains. The longer the uptrend, the longer the consolidation takes before resolving in either direction. The focus remains on finding opportunities within the sectors showing relative strength and managing risk as this process continues into the second quarter.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.