As we headdive towards fall in 2024, we are greeted by ominous headlines regarding stock indices in Asia hitting “limit-down.” A term used to describe the phenomena when stock prices crash fast enough to trigger market protecting circuit breakers. These circuit breakers are meant to stem the panic until market participants can breathe a little and the dust can settle, but should we be panicking yet? History says no. Specifically the yield curve says no, and even more specifically the 2y/10y curve. This specific part of the curve has a reputation for having quite the attitude when things don’t go her way, but… she has NEVER lied.
Around June of 2023 the spread between the 2 year and 10 year treasury bills went negative – meaning the yield on the 2 year was higher than the 10 year. This is not how things are supposed to work, and it is indicative of Mrs. Market predicting trouble. That trouble doesn’t always come immediately though. It usually takes anywhere from 6-24 months from inversion before a major stock decline or recession. In 2019 the yield curve slightly inverted in August exactly 6 months before Covid began causing market panic. This time however, it is taking a little longer. We are already at 28 months since the yield curve inverted briefly in April 2022, before bouncing and finally plunging into deeply negative territory later that year.
Today as I write this we have rebounded from that deeply negative territory and are sitting just below 0 at a -0.04 spread. If we are to believe her, we are nearing the precipice… and we have no reason not to. But we may still have some time to stock up before things get truly alarming. Of the last 10 recessions the yield curve uninverted 60% of the time before the recession started. For simplicity we can say a stock decline usually triggers, or marks the beginning of, a recession. After uninvesion, there were between 0-7 months before the market decline started during the last 6 recessions following uninversion, with the average delay from uninversion being around 100 days.
The chances are at least “more than half” that we have a little bit of time to get our ducks in a row before recession hits. So, have a few extra dollars stashed for easy bartering and next time you’re at the grocery store, don’t pass by those beans! It’s time to stock up on things that can last.
Oh, and one last point. There has been a 162% increase in margin loans and nearly a 13% increase in outstanding notional derivatives since 2007 leading to around $673 TRILLION in systemwide market leverage currently outstanding. So, spicy beans to match the spicy recession may be the move!
