I hope this blog post finds you well and informed about your investments. Today, I want to discuss a critical topic that can have a significant impact on the stock market and, consequently, your portfolios: the inverted yield curve.

A year ago, Tom McClellan, Editor of The McClellan Market Report, noted that the inverted yield curve was indicating a possible bottom for stock prices in 2024. However, there was a crucial condition attached to that prediction – it depended on the yield curve returning to normal by then. Unfortunately, what we’ve seen instead is a further inversion of the yield curve, which has some important implications.

To understand the concept, let’s simplify the yield curve. We compare just two rates: the 10-year and 1- year T-Note yields. By calculating the spread between these two rates, we can create a straightforward 2-dimensional chart. The actual yield curve is more complex and consists of all possible market yields on bonds from short to long maturities.

Chart Credit: Tom McClellan, Editor, The McClellan Market Report

Now, let’s refer to the chart provided by Tom McClellan. It compares the 10-year and 1-year yield spread, but with a twist – he has shifted the plot forward by 22 months. This helps us see how the stock market responds with a delay to the inversion of the yield curve. Typically, the moment of the greatest inversion is the key indicator, as stock market bottoms tend to arrive about 22 months later, on average.

As of now, we don’t know exactly when the yield spread will reach its most extreme point. If it happened to be today, we might expect a stock market bottom around May 2026. However, recent actions by the Federal Reserve, such as the quarter-point hike from the FOMC on July 26, 2023, which is pushing up the short end of the maturity spectrum, means that the bottom date for the stock market could be postponed even further.

It’s essential to acknowledge a notable exception to this 22-month lag principle. In 2019, there was a minor yield curve inversion in August to September, suggesting a stock market bottom ideally in June to July 2021. However, due to the arrival of Covid and the government’s response to the pandemic with economic shutdowns and massive financial stimulus, the stock market bottomed much earlier, in March 2020.

Now, let’s talk about the relationship between the yield curve and the unemployment rate. While the yield curve and unemployment rate are highly correlated, it’s crucial to understand that the yield curve is not the cause of changes in the unemployment rate. Instead, the Federal Reserve mainly influences the yield curve, and policymakers react to the state of unemployment.

Chart Credit: Tom McClellan, Editor, The McClellan Market Report

Interestingly, every time we witness an inverted yield curve, it leads to a significant rise in the unemployment rate in the following months. However, this time, the unemployment rate is taking longer to respond, which is good news for those who still have jobs. The Fed seems to believe in the possibility of a “soft landing” or “no landing” scenario regarding unemployment, but history suggests this belief might be misguided. Traditionally, rising unemployment has signaled the end of the inverted yield curve.

In conclusion, the further inversion of the yield curve, as observed by Tom McClellan, indicates that the bear market might be extended beyond our initial expectations. While the stock market tends to respond with a delay to the yield curve inversion, we should closely monitor how the unemployment rate evolves, as it has historically played a vital role in the overall economic outlook.

Knowledge is power, and we believe that staying informed about market trends and economic indicators empowers you to make well-informed decisions for your financial future. As always, our team at Advanced Wealth Management is here to support you on this journey. If you have any questions or concerns, please don’t hesitate to reach out. We value your trust in us and look forward to guiding you through these dynamic market conditions.

Tony Gomes CEO, Advanced Wealth Management

DISCLOSURE-Please note that this commentary is intended solely for the purpose of providing general information. It should not be interpreted as advice on investments, taxes, or legal matters and does not establish an attorney-client relationship. The past performance of any market is not indicative of future results. While the information presented here is sourced from reliable outlets, it is not guaranteed.