The Bond Market Just Sounded Its Most Severe Alarm in 50 Years. It Could Signal a Big Move in the Stock Market in 2024.
As signs of economic resilience grow, investors are increasingly considering the possibility of a “soft landing,” where the Federal Reserve curbs inflation without causing a recession. Despite the optimism that lifted the major U.S. financial indexes in 2023, analysts at JPMorgan Chase and Deutsche Bank remain cautious, seeing a recession as a distinct possibility in the next 12-18 months. The bond market, particularly the Treasury yield curve, is signaling its most severe recession alarm in decades.
The Treasury yield curve remains inverted: Treasury bonds, reflecting government-issued debt securities, pay interest based on their maturity date. The yield curve, a graphical representation of yields on Treasuries with different maturity terms, typically slopes upward for longer-term bonds. However, during economic distress, it can become inverted, where long-dated bonds offer less yield than short-dated ones. This inversion has persisted for the last two years, signaling potential economic challenges.
The yield-curve inversion is the bond market’s most severe recession alarm in decades: The spread between the yields of the 10-year Treasury and 3-month Treasury, a closely watched economic indicator, has inverted before all eight recessions since 1968, with only one false positive in the mid-1960s. The inversion occurred in October 2022 and remains inverted today, indicating a high probability of a U.S. recession by October 2024. The spread reached its steepest inversion in over 50 years, raising significant concerns.
What could a recession mean for the stock market? A recession could impact the stock market, with history suggesting a potential 31% decline in the S&P 500 if the economy slips into a recession. While historical averages imply a downside of approximately 29%, the severity of drawdowns can vary based on unique circumstances during each recession. Despite the potential challenges, staying invested is advised, as attempting to time the market may backfire.
Silver lining in case of a recession: While a recession could lead to a decline in the stock market, historical data shows a silver lining. The S&P 500 historically rebounded four to five months before recessions ended, generating a median return of 30% during that period. Investors who stay invested and maintain patience tend to be well-rewarded over time, with the S&P 500 returning an average of about 10% annually since its inception.
In conclusion, the bond market’s recession signal, the most severe in over 50 years, raises concerns about the stock market’s trajectory in 2024. Investors are advised to remain vigilant, stay invested, and consider historical patterns in navigating potential economic challenges.
