Why the Long-Term Picture is Bearish

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Traders will often argue about the short-term direction of the stock market.

Some folks are bullish. Some folks are bearish. Some folks straddle both sides of the fence.

We’re traders. That’s what we do.

But, as we argue about where stocks are headed in the short term, it’s important to keep the longer-term picture in mind. And that longer-term picture is bearish. VERY bearish.

Take a look at this monthly chart of the 10-year Treasury bond yield curve…

This chart shows the difference in yield between the 10-year Treasury note and the three-month T-bill.

Most of the time, the yield curve is a positive number – the further you go out in time, the higher the yield.

A negative yield curve – where short-term bills offer a higher yield than long-term notes – often occurs prior to an economic recession.

Indeed, the first four blue arrows on the chart occurred just prior to significant declines in economic activity.

They also occurred just before significant declines in the stock market. However, the declines didn’t happen while the yield curve was inverted.

In fact, when the yield curve reached its most negative levels, stocks were closer to their bull market highs than they were to their bear market lows.

The stock market declines occurred AFTER the yield curve shifted back into positive territory – when the yield on the 10-year Treasury note was higher than the 3-month T-bill. This usually happens when the Federal Open Market Committee shifts from a tight money policy – where the Fed is raising short-term interest rates – to an easy money policy where the Fed is lowering rates.

After declining to the steepest inversion in my lifetime, the yield curve has started to move higher. It’s still a long way from positive territory. But it is moving in that direction.

The market believes the Fed is nearing the end of its rate-hiking cycle and getting closer to lowering interest rates. Most folks seem to think that’s a good thing for the stock market.

And if Chairman Powell even hints at lowering rates in his speech at Jackson Hole tomorrow, stocks will likely put on a blistering short-term rally.

But if history is any sort of a guide, then the long-term picture is bearish. Stocks tend to perform poorly when the yield curve shifts from an inverted condition to an upward slope.

And since the yield curve was recently more inverted than ever before, the longer-term picture for stocks is quite bearish.

Best regards and good trading,

Jeff Clark

Where do you think stocks are headed next?

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