(Pure speculation follows)
Recently, seekingalpha brought up the topic of the yield curve again, suggesting an end to the recession in 2010. "Unlikely", the trader sentiment shouts out, but consider the paper published by Federal Reserve Bank economists Arturo Estrella and Frederic S. Mishkin:
Throughout the post WWII economy, every recession has been preceded by an inverted yield curve 4 to 6 quarters ago. Conversely, in all but two instances, inversion of the yield curve has preceded a recession 4 to 6 quarters in advance. An example of this recession follows (with a bit of speculation on my part as far as the W is concerned):
The claim is that opposite signals have relevance also; a steep yield curve marks the end of the recession just as the inverted yield curve marks the beginning. Spreads between the 3 month and 10 year treasuries have certainly reached end-of-recession peaks (1982, 2000)
The trumpet gives a bit of history:
So just what does this latest yield curve inversion mean for the economy?
Many analysts are saying it means nothing because the curve has become less predictive than it once was. Additionally, some people say that compared to other inversions, this one so far is minor and therefore nothing to worry about. Even Federal Reserve Bank Chairman Alan Greenspan says it’s different this time (ibid., Dec. 27, 2005).
However, “It’s different this time” is the exact reasoning most major Wall Street banks used when the yield curve inverted in 2000—after which the stock market crashed and the economy went into recession. Prior to the crash, banks said the government was running a budget surplus and was therefore selling fewer long-term bonds. They explained how this pushed long-term bond prices up, and their yields down, causing an inverted yield curve. Deutsche Bank, for example, said, “When this spread went negative in the past, it either foreshadowed a recession or a sharp slowdown in growth …. Fortunately for Main Street, we do not think the … [yield] inversion is sending us that message” (ibid., Dec. 29, 2005).
I still believe that a substantial (>10%) correction will occur along with market participants bailing, but the bullish case is being reinforced by all the negative sentiment I see thrown around on public forums. The biotech position remains (well, mostly as I switch brokers to thinkorswim)
This time, the analysts have been proven wrong again, as usual. How about 4 quarters into the future?
PS Dshort remains a valuable source for the long-term investor to track bear market recoveries.
