E-Wave for the S&P 500 Index

[JLS]

It's all about ...

the Dynamic Yield Curve, stupid!

Very sorry, I just couldn't resist.

For many investors, 2023 might be the first time to consider bonds in their adult lives.

That’s the takeaway from an insight published recently by Goldman Sachs, which forecasts that 2023 bond yields will exceed stock dividends. This, the paper says, hasn’t happened since the height of the Great Recession in 2008.

Per the report:

"While the stock market might get more press, the U.S. stock market total capitalization is actually a bit smaller than the bond market, though neither is small. The stock market has just over $30 trillion in total market capitalization, meaning the value of all outstanding shares, while the total amount of debt owed through bonds is more than $40 trillion.

Why does that matter?

Because it’s all about the inverted yield curve, stupid!

A yield curve is a line that plots yields, or interest rates, of bonds that have equal credit quality but differing maturity dates. The slope of the yield curve can predict future interest rate changes and economic activity.

There are three main yield curve shapes: normal upward-sloping curve, inverted downward-sloping curve, and flat.

Normal curves point to economic expansion, and downward-sloping curves point to economic recession.

Why is that so important?
A flat yield curve reflects similar yields across all maturities, implying an uncertain economic situation. A few intermediate (bond) maturities may have slightly higher yields, which causes a slight hump to appear along the flat curve. These humps are usually for mid-term maturities, six months to two years.

The curve shows little difference in yield to maturity among shorter and longer-term bonds. A two-year bond may offer a yield of 6%, a five-year bond of 6.1%, a 10-year bond of 6%, and a 20-year bond of 6.05%. In times of high uncertainty, investors demand similar yields across all maturities.

Why Does the Yield-Curve Slope Predict Recessions?

Many studies document the predictive power of the slope of the Treasury yield curve for forecasting recessions. This work is motivated, for example, by the empirical evidence which shows the term-structure slope, measured by the spread between the yields on ten-year and two-year U.S. Treasury securities, and shading that denotes U.S. recessions (dated by the National Bureau of Economic Research). Note that the yield-curve slope becomes negative before each economic recession since the 1970s. That is, an “inversion” of the yield curve, in which short-maturity interest rates exceed long-maturity rates, is typically associated with a recession in the near future.

So here's the largest yield curve inversion I've seen in my many trading years (so I decided to take a trading break for a while).

https://stockcharts.com/freecharts/yieldcurve.php