In macroeconomics, the yield curve is used to predict the probability of a recession. When the curve inverts, it means that short-term yields have been higher than long-term yields for more than two years until last week. This puts investors on edge because an inverted yield curve has historically led to recessions. The build-up period can be quite significant once the inversion is complete, but investors are justifiably concerned about the implications for the stock market. We look at relations from a technical point of view. We can graph the yield curve by subtracting the 2-year US Treasury yield from the 10-year US Treasury yield. When the yield curve turns positive after being negative for a long time, it has been a harbinger of recessions, albeit with a small sample size. Note that the yield curve has just turned positive after a long-term inversion, so it is timely to consider the macroeconomic picture. Looking back 40 years, there are only three previous occasions when the yield curve turned positive after a long period of inversion: 1989, 2000, and 2007. Technically, we are most interested in how the yield curve “signal” works. market timing perspective on the stock market. All three events led to recessions, but with varying lags, and the effect on the S&P 500 Index was also reversed in three cases: in June 1989, the yield curve turned positive, leading to a cyclical bear market in late 1990. with a reduction of about 20%. However, the signal was early, as the SPX rose another 10% by October 1989. The yield curve also signaled a bear market during the Great Financial Crisis, but the signal was 7 months early and the SPX rose nearly 10% before peaking. The most timely signal was in late 2000, which roughly coincided with the beginning of the bear market period. In conclusion, the yield curve has indeed pointed to recessions and bear markets in the past, but we would not trust the yield curve by itself because of the lead-lag relationship of financial markets and the economy. Also, the small sample size of the signals reduces the statistical legitimacy. The solution to these shortcomings is to use technical analysis to confirm the signal from the yield curve. When long-term momentum indicators roll in for the S&P 500, the downward yield curve signal becomes more relevant. — Katie Stockton from Fairlead Strategies with Will Tamplin Access research for free here. DISCLAIMER: (None) All opinions expressed by the authors of CNBC Pro are theirs alone and do not necessarily reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, nor any previously expressed by them on television, radio, internet or any other medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND PRIVACY POLICY. 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