An inverted yield curve historically has been a reliable indicator of a looming economic recession, and that has a growing number of investors poised to dump stocks as recessionary expectations often trigger bear markets. Not so fast, say analysts and strategists at JPMorgan and Credit Suisse. "Historically, equity markets tend to produce some of the strongest returns in the months and quarters following an inversion," Marko Kolanovic, global head of macro quantitative and derivatives research at JPMorgan, wrote in a recent note to clients cited by MarketWatch.
Andrew Garthwaite, global equity strategist at Credit Suisse, has a similar view. While noting the U.S. economy has slipped into a recession within 15 months after each of the last seven yield curve inversions, he also points out that stock prices typically peak six months after an inversion begins, per CNBC. He also finds that certain stock market sectors and industries tend to do well after an inversion, several of which we highlight in the table below.
5 Sectors That Perform Well After The Yield Curve Inverts
- Health Care Equipment
- Food, Beverage and Tobacco
- Defensive sectors in general
Source: Credit Suisse, as reported by CNBC
Significance For Investors
Looking at historical performance, Garthwaite calculates that the S&P 500 Index (SPX) has risen 75% of the time during the first three months after an inversion started, averaging a 4% increase. However, 18 months later the index was down 62% of the time, with an average decline of 8%.
Shifting his focus towards stock market sectors, Garthwaite finds that insurance and industrial stocks deliver the best median historical performance in the first three months after an inversion begins. At the other end of the spectrum, semiconductors and consumer durables typically performed the worst. Insurance normally remains among the best performers 12 months out, joined by other defensives such as health care equipment, pharmaceuticals and also food, beverage and tobacco stocks.
The classic defensive stock enjoys relatively steady demand for its products across all stages of the business cycle, and thus is poised to deliver stable profits and dividends. By contrast, cyclical stocks, such as automotive and technology hardware manufacturers, historically are among the worst performers after 12 months, per Credit Suisse.
According to his research, Kolanovic of JPMorgan finds that the bull market still may have considerable room to run. "Only after [around] 30 months [after a yield curve inversion] does the S&P 500 return drop below average," he said in his note. As with four previous inversions, he sees the Federal Reserve and slowing economic growth as the 2 main drivers of the current episode.
While Credit Suisse asserts that yield curve inversions are reliable predictors of upcoming recessions, other analysts disagree. "Not every inversion has been followed by a recession," according to financial research firm Bespoke Investment Group, which also finds that the S&P 500 has tended to post strong gains within the first 12 months after an inversion.
Meanwhile, macro investment analytics firm Bianco Research finds that inversions only become reliable recessionary predictors when they last for 10 days or more. The current inversion is now in its fourth day. Yields were down at both ends of the maturity spectrum in early trading on March 27, as investors anticipated future rate cuts by the Fed, per another CNBC report. It remains to be seen whether this expectation materializes, and, if it does, whether a rate cut can head off a recession.