Grading on a Curve (the Yield Curve, That Is)

September 29th Weekly Market Update

Kids are back in school and have started taking tests. Some of those tests are graded on a curve, meaning that students are graded based on their score relative to the rest of the class. In terms of stock market indicators, one that gets an A+ and ranks at the top of its class is another type of curve — the yield curve. In fact, this indicator receives a perfect score (seven for seven) in signaling recessions over the past 50 years.

The goal for all investors is to find indicators to help anticipate big down moves, and the yield curve has been about as good as it gets on that One of the Five Forecasters featured in our Mid-Year Outlook 2014: The Investor’s Almanac Field Notes the yield curve passes the test as an indicator that has consistently signaled increasing fragility of the U.S. economy and a transition to the late stage of the economic cycle, an oncoming recession, and ensuing market downturn.

Many market participants have become worried (if not obsessed) about when the Federal Reserve (Fed) may start hiking short-term interest rates. Most economists and Fed watchers currently expect the Fed to begin rate hikes sometime in mid- to late 2015. But history shows the start of rate hikes, which may initially spark modest, but brief, stock market weakness, does not really alter the longer-term upward trajectory of stocks during an economic expansion — as we discussed in our Weekly Market Commentary “Ready, Set, Hike!” on August 25, 2014. History tells us that the difference between short-term rates and long-term rates matters more, and the Fed has much more influence over short-term rates.

For the full article: Grading on a Curve (the Yield Curve, That Is)