Is the yield spread telling us to be careful for 2018?
2017 is closing. 2018 is believed to be not as good as 2017 for equities investing. We have also just witnessed the third rate hike in US. Equities valuation is commonly believed to be very high. I bet many of us would be very concern about major market adjustment. As we approach the new year, it's always good to take a look at some fundamental factors. The US Treasury yield spread is an important factor that worth our attention. I have downloaded the graph from StLouisFed.org to see if we can spot anything meaningful. The chart above contains 10 yr treasury mature rate (blue line) and 2 yr treasury mature rate (red line) and the spread (10yr minus 2 yr) between them (greed dotted line).
Yield spread crossing below zero a few years before recessions
- Both 10yr (blue) and 2yr (red) yields have been in down trend since height in 1980s
- 2yr trend line seems a lot less volatile as it approached zero since 2013.
- 2yr trend line is now slowing crossing up while 10 yr yield trend is flat. Thus the spread is closing and approaching zero.
- Recession is usually preceded by yield spread crossing below zero. Please bear in mind that the "official" recession is much "slower" than the point of down turn. So we should have seen the impact in the stock market at the point of yield spread crossing down zero or even before.
Where are we today?
The red arrows in the chart above indicate yield spread level in history similar to the level as in today Dec 2017. The pattern seems rather random. It seems the yield spread crossing zero is more meaningful.
Any thing conclusive?
We all know that yield spread is a pretty "rough" indicator. History may repeat itself in high level but the details are never really the same. In 2017, we have witnessed low interest rate that we have not experienced before. Many analysts claimed that the boom cycle we are experiencing today should be much longer than before due to low interest rates, low GDP growth and low inflation. However, I am very much concerned that the 2yr yield is shooting up and seems to be crossing 10 yr yield soon. While I do not believe that we can humanly possible to anticipate market peak so there is no point of worrying about the peak everyday, I do want to have protective stop on each and every trades I have in 2018.
Disclaimer: I am no expert in economy nor am I a professional financial consultants. I study this for the sake of my own investment and I do not advise others for investing. I write in this blog so I can discuss it with other people so I can learn something. Please use the information and contents I have written base on your own judgement and take responsibility for your own investment decision!