U.S. stocks are near all-time highs again despite a flat U.S. Treasury yield curve that only un-inverted a two weeks ago, with the two markets signaling different views on the economy’s health.
The divergence between booming risky equity assets and lingering economic growth worries baked into the bond-market aren’t new, according to bearish strategists at Société Générale. In fact, in the last two economic cycles, stocks were close to their cyclical peaks before they “cracked under the weight of slower growth.”
“One asset class will ultimately be wrong, and history favours siding with the bond market,” wrote Jason Daw, an analyst at Société Générale. “Conflicting signals from the curve, equities, and monetary policy, coupled with uncertainty surrounding the depth and longevity of the downturn, should not obscure the dangers of owning risky assets.”
The S&P 500
was up 0.53% on Friday above its all-time record close of 3,025.86 set on July 26, FactSet data show.
The spread between the 3-month bill
and the 10-year note yield
, an indicator of the yield curve’s slope, stood at a positive 10 basis points on Thursday, compared with negative 51 basis points on Sep. 3.
An inversion or a very narrow yield spread is widely seen as a prelude to an economic downturn, and is employed by the likes of the New York Federal Reserve in their recession models.
Daw said if investors looked at other leading indicators of global economic growth such as purchasing manager surveys, freight orders, and exports, the state of the U.S. economy looked dim.
“Our economists believe that the U.S. expansion is on its last legs and that a recession should be apparent by mid-2020,” he said.
Some stock-market bulls have taken solace in the recent steepening of the yield curve, which still remains near very-flat levels. A wider spread between short-term and long-term rates can serve as a sign that investors anticipate growth and inflationary pressures that can weigh on long-term bond prices, pushing their yields higher.
But Daw warns that could give a false sense of comfort, as the yield curve had steepened sharply following an inversion at the end of the last two economic cycles in 2001 and 2008-09’.
In the chart below, Daw shows that the S&P 500 and the shape of the yield curve’ slope diverged prior to the last two recessions. “Rapid steepening of the curve after inversion such as in the past couple of months is not a good sign,” he said.