Stocks could perform well despite an inverted yield curve, Leuthold’s Jim Paulsen said. Paulsen noted that previous inversions saw a gain in the S&P 500 over the following years five out of nine times. The S&P 500 may also have already discounted future headwinds, making losses from here minimal. Loading Something is loading.
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An inverted yield curve isn’t as bad for the stock market as investors may fear, according to Leuthold Group’s Jim Paulsen, who says stocks may actually have an “agreeable” performance in the coming years despite bond yields flashing warnings of an incoming recession.
The spread between the 10-year Treasury yield and the 2-year Treasury yield is a notorious indicator of a pending downturn, with inversions predicting recessions in 1990, 2001, and 2008. The yield on the 2-year on Friday was around 4.31%, while the 10-year yield was 3.54%. The 3-10 Treasury spread, which Powell has said is his preferred recession indicator, has also been inverted.
It has prompted some degree of panic on Wall Street this year, with many analysts telling investors to brace for a recession in 2023. Bank of America last week said that stocks could fall 24% as a recession ravages the economy next year, and top economist David Rosenberg said an inverted yield curve means stocks are “nowhere near a bottom,” warning investors of more pain to come.
But the potential downside may be overstated, Paulsen said in a note on Friday. He pointed to the last nine inversions on the 3-year and 10-year yields, noting that the average return on the S&P 500 in the years following an inversion were “surprisingly positive.” The index typically rose 6% the year after an inversion, and 14% in the next year. Five out of nine times, the stock index posted gains in the following years.
“While yield-curve inversions have customarily unleashed havoc on the economy, job creation, and even profits, they are not nearly as bad for the stock market as commonly advertised,” Paulsen said.
Losses are especially minimal when the S&P 500 discounts future headwinds before the yield curve actually inverts, he added, such as in 2019, when the index was already down 20% before the 3-10 curve inverted. The index went on to perform well in the following years, before the shock of the pandemic.
That could also be the case for this year’s inversion, as the S&P 500 was already down 25% before the 3-10 spread inverted in October – suggesting the downside may not be as bad as expected.
“Notwithstanding today’s pervasive worries about a death sentence for stocks being prompted by the recent yield-curve inversion, history suggests any fallout will probably prove less damaging than presumed, and the S&P 500 could well surprise on the upside,” he said.