As the old saying goes, “those who do not learn from history are doomed to repeat it.” This sentiment seems particularly relevant when considering the charts that have been circulating lately predicting a stock market crash.
One chart in particular that has been making waves is the 10-year Treasury minus the 3-month Treasury yield curve.
While most of us are used to looking at the 2s and 10s, this chart specifically looks at the 3 months and 10 years. If the number is negative, that would mean an inverted yield curve.
So what's the significance of this chart? According to macroeconomists, it predicts when we could see a stock market crash. The 3-month tenure officially inverted in October of 2022, making that a key date to watch out for. After this initial inversion, continuing claims for unemployment peak at around 18 months for various recession periods.
But what does this mean for the stock market's trajectory? If we look at the past three decades, after an initial inversion of the 10 year and the three months yield curve, we see that the stock market tends to go up. But its peak usually happens after 15-18 months, and then it just plummets. What's more, every single time this has happened, without fail, the stock market has crashed. While the market doesn't crash in a straight line, the yield curve has remained undefeated, undefeated across macroeconomics for a considerable amount of time.
Therefore, what we're seeing now is just a warning sign, indicating economic turbulence ahead. While it's uncertain whether this turbulence will hit in six months or two years, it's not smart to bet all your cards on the stock market right now. Defend your positions and increase your cash position because, as we've seen before, storms clouds are circulating on the horizon.
Capital preservation should be your number one priority, and the highest probable outcome is a stock market crash in the average of the preceding inversions, which is around 16-18 months. If you have patience, you can ride it out and wait out the storm before jumping back in. Remember, stay vigilant, and don't bury your head in the sand.