Signs that a Bear Market May Be Coming

A recent article in Barron’s reports that while a flattening yield curve is “no reason to bail out of stocks,” bond yields could provide investors with “a sell signal in the years ahead.”

A flattening of the yield curve occurs when short-term bond yields rise faster than long-term yields, which can happen, the article explains, if investors “think the Fed is making a mistake” in hiking interest rates and may have to reverse its course. A flattening can make investors nervous since it can precede an inversion (short-term yields exceeding long-term), which the article points out “has historically been a warning sign of a coming recession, and bear market for stocks.”

A recent report by J.P. Morgan’s global stock strategists argues, however, that the Fed Funds rate remains “modest relative to the rate of inflation” and that investors need not fear a flattening of the yield curve. Historically, it says, the S&P 500 has posted positive returns during each of the six “flattening” periods since 1980 (with a median return of 9%).

“In other words,” the article concludes, “if history is a reliable guide, stock investors should shrug off flattening bond yields and stay invested, until the yield curve inverts, after which it will perhaps be time for some orderly profit-taking, but not panic selling.”