Treasury Yield Curve
Small Caps: We’ve Seen This Setup B-Four
In mid-2020, we wrote that a new multi-year leadership cycle had probably begun. Technically, that belief hasn’t been disproven, but the extent of outperformance has been disappointing in the nearly three years since.
The Yield Curve Meets Microsoft Excel
To our surprise, the measure that most closely correlated with real-GDP growth on a one-year time horizon is the rarely mentioned Treasury spread for the 5-Yr./3-Mo.
The Yield Curve And The Problem Of Timing
Frequently, there’s money to be made in the stock market in the months following the initial curve inversion. After the inversions of August 2006 and June 2019, the S&P 500 rallied another 23% and 19%, respectively, into its final bull market high. If this cycle plays out in textbook fashion, the business-cycle peak would arrive in September.
The Inversion Before The Inversion
We found the spread between the “Expectations” and “Present Situation” series (the “Confidence Gap”) has historically moved almost in lockstep with the yield curve. As the Confidence Gap plummeted throughout 2021, the implication was the yield curve would soon follow. After some initial resistance, it did.
Goodbye Inflation, Hello Recession?
Unlike the five prior cycle peaks, this year’s inflation peak materialized during an ongoing economic expansion. That implies the “post-peak” monetary policy has never been tighter than today—making a soft landing even more improbable.
How This Year’s Inflation Peak Differs From Its Predecessors
Our studies of economic and stock market history are meant to provide perspective, not an investment roadmap. But occasionally a current trend will resemble the past so closely it’s eerie.
Take the current inflation cycle. If (as we believe) June’s CPI inflation rate of 9.1% represents the peak for this business cycle, then many of its characteristics have lined up almost perfectly with the “average” of past inflationary episodes.
Which Yield Curve?
Last month’s inversion in the 10-Yr./3-Mo. Treasury spread further tilts an already lopsided scale in favor of a U.S. recession in 2023. That spread has been considered the gold standard from an economic forecasting perspective, and is the basis for the New York Fed’s Recession Probability estimate (which, by the way, should break above its critical 35% threshold when it’s published later this month.)
More Signs Of Peak Inflation
As suggested in our June 24th, Chart of the Week, the peak in consumer inflation (+8.6% in May) has likely either occurred or is imminent. Consumers should thank the stock market, which in 2022 has taken up its occasional role as inflation-fighter after the Fed abdicated throughout 2021.