In addition, we calculated each indicator’s correlation with forward S&P 500 returns, and how much of a warning, measured in months, they gave for impending market crashes.
The findings help answer a timeless (and timely) question: can any leading indicator be consistently trusted to stay ahead of market declines?
Download the new White Paper—which also looks at S&P 500 PE Ratio, CAPE Ratio, The “Buffett Indicator”, Tobin’s Q, and Negative S&P 500 Earnings Growth—for our full findings:
How Accurate are Negative 10-2 Year Yield Spreads At Predicting Market Declines?
Out of a possible 13 major market declines dating back to May 1976, the 10-2 Year Treasury Yield Spread flipped negative in advance of 6 of them. It also inverted three months after the start of the 2022 market decline—a late warning for anyone trying to time the action.
With a success rate of 46%, Negative 10-2 Year Spreads are by no means a perfect indicator of stock market declines. However, relative to other leading indicators studied, Negative 10-2 Year Spreads provided timely notice ahead of market declines. The average time between the 10-2’s initial inversion and the S&P 500’s relative peak was 10.57 months across the six market declines. In addition, the 10-2 Year Spread inverted multiple times before some of the six market declines had started, providing additional “heads-up” that long-term investors might have appreciated.
The 10-2 Year Spread’s best timing of a market decline, arguably, was 2000-02. Had you exited the S&P 500 when the spread turned negative on February 2nd, 2000, you would have “taken the money and ran,” just 1 month, 22 days prior to the start of the dot-com crash.
While the 10 Year-3 Month Spread also hasn’t been a perfect arbiter of market declines, a success rate of 50% is a slight step up from its 10-2 Year Spread cousin. On average, the 10 Year-3 Month Spread inverted 12.9 months in advance of eight major market declines (like the 10-2 Spread, multiple inversions preceded some market crashes). Effectively, this means the 10 Year-3 Month Spread also provided several wake-up calls before some market declines—a great thing if you had hit the snooze button once or twice.