The yield curve and forward 3 year returns

Currently in Sunday night trading, the 10-year 2-year spread sits at a paltry 25.4 bps. The recent surge in yields with their test of 3 percent seems but a fleeting flirtation, like the bored housewife making a pass at the cable guy. Only the housewife then comes running back to the arms of her US hubbie after she realizes the cable guy is actually an autocrat of a middling Middle Eastern regime named Recep with not the faintest understanding of how his absurd policies are destroying the wealth of his country while flipping the middle finger to the entirety of the economic world in the process.

With that said, I thought it would be interesting to take a historical look at what the yield spread has implied for equities over its subsequent 3 years from its current levels.

Looking at all of the data from 1990 onward, the answers are not great:

The worrisome implications of the yield curve (at least as they relate to the historical statistical relationships which have held since 1990) is that levels under 0.40 begin to be the realm where things are a bit bimodal. Yes, sometimes things work out extremely well for those holding equities (as transpired in the mid 1990s), but in the longer term, it seems that this threshold is associated with late cycle dynamics. We see a large variance of returns, with a few periods in there of absolute crap where you start to have the risk of some life-alteringly poor returns.

It seems as though the threshold of 0.3 to 0.4 becomes a bit of a Rubicon where the recessionary pressures are virtually unavoidable and recessions begin to assert themselves. This becomes more clear when we look at the average return for each 10 basis point move in the value of this spread:

When viewed in this way, the dropoff is pretty staggering and, unfortunately, we are now solidly in the area where things perform poorly.

Read more about the nature of recessions and why this matters