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Forget the doomsayers, yield curve inversion is buy signal

The bond market just flashed its biggest recession signal ever, but one strategist said it’s time to buy stocks.

A key part of the bond market inverted Wednesday when the yield of the 2-year Treasury rose above that of the 10-year Treasury, a phenomenon that for half a century has accurately signaled coming recessions. However, it typically takes nearly two years for a recession to occur after the yield curve inversion, leaving investors room to still reap gains from the stock market, according to Tony Dwyer, analyst at Canaccord Genuity.

“A curve inversion is an intermediate-term buy signal,” Dwyer said in a note to clients on Wednesday. “The initial inversion of the 2-/10-year UST yield curve works with a lag … Our still-positive core fundamental thesis continues to suggest any weakness should prove limited and temporary and provide a more attractive entry point for a move toward our 2020 target of 3,350.”

The S&P 500 has gained 21% on average in the two years before a recession, the strategist pointed out. Furthermore, in the last three cycles which are the most similar to the current environment, the S&P 500 rose 34% on average before the economy reached its peak and a recession hit about 25 months after the yield curve inversion, Dwyer said.

The yield on the benchmark 10-year Treasury note broke below the 2-year rate early Wednesday, sending stocks plunging. The last inversion of this part of the yield curve was in December 2005, two years before a recession brought on by the financial meltdown.

Investors, worried about the state of the economy, rushed to long-term safe haven assets, pushing the yield on the benchmark 30-year Treasury bond to a new record low on Wednesday.

“The drop in global interest rates that has come with the weaker global data should cause a rebound in economic activity as we head toward year end,” Dwyer said. “There is no sign in our credit metrics that indicates a shutdown in money availability that would make the lower rates less impactful for forward growth expectations.”