The yield curve is widening, and that’s a bad long-term sign for the stock market.
Traders might remember last year when the yield curve went negative. Long-term interest rates had fallen below short-term interest rates. That doesn’t happen often. And, when it does, it’s usually an indication of economic weakness to come several months later.
So, when the curve inverted in mid-2019, the financial media was understandably concerned about an impending recession.
Now, though, the curve is back to normal. Long-term interest rates are higher than short-term rates. Just about nobody is concerned about a recession. Instead, nearly everyone is focused on the recovery.
But, if history is any sort of a guide, this is exactly the time where stock market investors should be concerned.
You see, the spread between long-term and short-term rates looks set to explode higher. And, the last two times that happened, the stock market collapsed.
Take a look at this long-term, monthly chart that shows the difference between the 10-year Treasury note and the three-month Treasury bill…
The current condition of this chart looks eerily similar to the conditions back in 2001 and 2007 – just before the yield curve expanded quickly, and the stock market declined.
Back then, the Fed kept short-term interest rates low. But, the financial markets demanded higher yields on longer-term Treasury debt. That’s similar to the situation we have today – with the Fed announcing it will keep short-term rates near 0% through “at least 2021.” Meanwhile, longer-term interest rates have been ticking higher over the past few months.
As a reminder, here’s how the S&P 500 performed following 2001 and 2007…
The S&P 500 is trading near its highest level – ever. Investors are enthusiastic. Folks are expecting a strong economic recovery. And, the Fed has promised to do everything it can to keep the party going.
But, it looks like the bond market has other ideas. If longer-term interest rates continue to press higher, as the Fed keeps short-term rates pegged at zero, then that spells trouble for stocks.
Best regards and good trading,
Jeff Clark
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