Many observers are posting that the dis-inverting yield curve is the real signal of a recession.
Historically speaking it is true that when the yield curve dis-inverts, ie. the short term rates starts to fall when the FED cuts, the economy is in trouble (unemployment goes up) and the stock market tanks (2001, 2007/08).
The only reason why the economy and stocks can avoid the same outcome is if the economy can achieve a soft landing. Now it is true that certain parts of the economy is already weak or contracting. Manufacturing is one, according to the ISM surveys. The contraction is in its fifth consecutive month. Unemployment is also inching up, triggering the now famous Sham Rule. There is also a rise in delinquency in consumer loans. All these point towards a weaker economy.
Yet, the signals from financial markets is starkly different.
Unlike the previous dis-inverting periods, the signs from markets are more positive. Market breadth was very weak in 1999-2000, and in 2007-08. When the yield curve dis-inverted, many stocks were already in a bear market. The Advance-Decline index was trending down during those periods.
Currently, the signal from markets are more positive. More stocks are participating in the current rally. Even industrial stocks are in an uptrend, defying the results of the ISM surveys. Hence, we conclude that there is a significant chance that the economy can do a soft landing, arresting the increase in unemployment and continuing the economic expansion.
