The inverted yield curve is setting the stage for a significant stock market rally, according to Canaccord Genuity’s chief market strategist Tony Dwyer.
“Over the past seven economic cycles, every recession was preceded by an inversion of the curve, but not before an extended lead time to recession and significant gains in the [S&P 500] to peak,” he wrote in a note to clients.
Canaccord’s 2020 target on the S&P 500 is 3,350.
The inversion of a key part of the yield curve began this month, with the 2-year Treasury yield trading above the 10-year yield (^TNX). An inverted yield curve may give banks less of an incentive to loan money, amid thinner profit margins. Less lending could slow the economy and spark a recession.
The inverted yield curve and subsequent recession worries have contributed to the stock market volatility so far in August, with the S&P 500 (^GSPC) down 3.5% from its July 26 record closing high. But at one point this month, the S&P 500 was down as much as 6.8% from that record threshold.
“In fact, looking at the last three cycles that have been similarly fueled by an excessive use of leverage, following the initial inversion of the curve the [S&P 500] rallies a median 34% in 22 months with a recession 24 months away,” he wrote.
When the yield curve inverted in December 2005, the S&P 500 peaked in October 2007, rising roughly 25% during this time period. The recession started two months later in December 2007.
Inverted yield curve messaging
Dwyer also pointed to the importance of the recession signal the inverted yield curve has traditionally sent.
“Over past cycles, when the 2-10-year U.S. Treasury yield curve inverts, many policy makers, investors, economists, and strategists believe there may be an artificial reason and, therefore, may not be signaling recession,” he wrote.
Some strategists have chalked up the recent plunge in U.S. yields to the increasing amount of negative yielding sovereign debt globally, most notably in Europe.
“We refuse to make the ‘it’s different this time’ mistake, but we want to spotlight that once the curve does invert, it takes a very long time to shut down the levered economic engine and create ‘the’ market peak and recession,” he added.
Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.
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