The Dow Jones Industrial Average fell drastically on Wednesday, shedding over 800 points as the markets retreated in what was the biggest single-day decline so far in the year. Backed by fresh warning signs regarding the government-bond market, anxiety on Wall Street about the potential for an economic downturn have never been higher.
The index dropped by 800.49 points, of 3.1 percent, led by sharp declines in economically sensitive sectors like manufacturing and banking. Major companies like Boeing fell by 3.7 percent, while Citigroup, one of the most active U.S. banks internationally, fell by 5.3 percent.
Other indexes such as the S&P 500 and the Nasdaq composite fell by 2.9 and 3.0 percent respectively. While weak economic data out of Germany and China have fueled fears around the world, the major factor leading to today’s drop came from the bond markets which gave a major warning sign.
The yield on the benchmark 10-year Treasury note again fell below the 2-year rate, often simply referred to as the inverted yield curves, have been an accurate predictor of economic recessions over the past 50 years while also scaring investors each time they appear.
As investors worry about the state of the economy, they rush to long-term safe-haven assets such as long-term government bonds, which pushes down the yield of the benchmark 30-year Treasury note. On Wednesday, the bond reached a new record low due to the influx of scared investors.
“Whether we go into recession now or we don’t, it’s not a good sign. You’re going to see investors temper their enthusiasm more seriously today,” said Michael Farr, president of investment firm Farr, Miller & Washington according to The Wall Street Journal. “The U.S. equity market is on borrowed time after the yield curve inverts,” added Bank of America technical analyst Stephen Suttmeier in a note according to CNBC.
So far, there have been five major inversions between the two yield curves since 1978, all of which accurately anticipated a recession. However, in some of these cases, there was a significant lag.
On average, a recession occurred 22 months after the initial inversion in each of these instances. Interestingly enough, the S&P 500 enjoyed average returns of around 15% for the 18-month period after an inversion happens but before the recession begins, suggesting that there’s still some room for the market to make a last, final rally before the downturn comes.
Despite this research being readily available, many retail investors aren’t aware of this fact and have jumped on the bearish bandwagon as the financial press covers the story. To further prove the previous point, the last time a major yield inversion took place was back in 2005, a full two years before the recession that came from the real estate bubble.
The hype surrounding this phenomenon even has gone so far as to reach the ears of President Trump, who recently tweeted that he found the yield curve situation “crazy” while criticizing the fed for not cutting interest rates fast enough. “CRAZY INVERTED YIELD CURVE! We should easily be reaping big Rewards & Gains, but the Fed is holding us back. We will Win,” tweeted the President.