Even with another part of the US Treasury yield curve showing signals of recession, US equities are not necessarily set to fall in 2023, according to James Paulsen, chief investment strategist at Leuthold Group.
A generally reliable indicator of recession in the nearly $24 trillion US Treasury market emerged about a month ago, when the 10-year Treasury yield TMUBMUSD10Y,
fell below the 3-month invoice TMUBMUSD03M,
assess. The “inversion” of this part of the Treasury yield curve highlighted growing concern among investors about the outlook for the economy.
On Friday, the 10-year yield was close to 3.55%, while the 3-year yield was closer to 4.34%.
“Ouch!” Paulsen wrote, in a client note Friday, adding that since the 1960s, “an inverted yield curve has had a near-perfect record for predicting a recession within two years. And everyone knows that the stock market does not react well to impending recessions.
However, he also created this chart showing the SPX of the S&P 500,
generally positive total return one year and two years after the first month of a 10-year/3-month yield curve inversion since 1965.
Yield curve inversions don’t always mean stocks are lower a year or two later.
Leuthold Group
Admittedly, the average return one year after each inversion was 6%, while it was 13.9% on average two years later.
“That is to say, overall, while yield curve inversions have usually wreaked havoc on the economy, job creation and even earnings, they are not as bad for the stock market than what is generally advertised,” Paulsen wrote.
A deviation from the trend occurred when investors weren’t worried enough about stocks entering a recession, especially in 2000 when stock market investors were caught off guard by the dotcom crash. , which has seen the S&P 500 post consecutive annual declines. 14.3% and 23.6%, respectively.
However, the S&P 500 had already fallen about 25% from its peak this year when this key part of the yield curve inverted in October.
“As a result, given that investors are particularly worried about the recent reversal and the stock market has already adjusted lower, any further pain could be far less than expected,” according to Paulsen, who also said, ” it is very likely that the stock market will perform nicely over the next couple of years.
A key caveat, however, for this cycle of monetary tightening has been a Federal Reserve using a series of giant interest rate hikes this year in its fight against stubbornly high inflation, but while also aiming to avoid triggering a recession.
And Friday’s surprisingly strong November jobs report could derail the Fed’s tentative plans to start raising rates at a slower pace later this month.
See: US jobs data put huge interest rate hike back on the table at December Fed meeting
Le Dow Jones Industrial Average DJIA,
was down around 100 points on Friday, or 0.3%, while the S&P 500 was down 0.6% and the Nasdaq Composite Index COMP,
was 0.8% lower.