Yield Curve and S&P Returns

The objective of this paper was to explore the predictive power of the US Treasury yield curve spread for subsequent short- to medium term S&P 500 returns (holding periods of 1-36 months), over the past 35 years. Stock returns were lowest (and even negative) when the yield curve inverted, especially if the spread was increasing - a situation that usually coincided with monetary policy changing from restrictive to expansionary (the so-called “Fed pivot”). On the other hand, a positive yield curve was typically followed by positive stock returns in mostly all examined holding periods. The highest average returns were recorded when the yield curve was normal and the spread decreasing – i.e., when the economic and stock market recovery was well underway and when the steep yield curve gradually started to flatten and normalize. Regression analysis indicated that, in the short-term, yield curve spreads and stock market returns are uncorrelated, but also that the relationship strengthened in longer time frames (although only to moderate levels). In this regard, using the 12-month MA spread instead of the current spread is perhaps worth further investigating, since it produced more consistent and statistically significant returns (especially for time frames of 12 months and longer).