By Sara Schaefer Munoz
Stocks closed down sharply Wednesday, following a worrisome signal in the Treasury market that spooked investors.
Yet they should take heart: If history is a guide, the S&P 500 actually tends to gain following such a signal, called an inverted yield curve.
On Wednesday, the yield on the U.S. 30-year Treasury bond touched 2.018%, while yields on the 10-year Treasury note briefly fell below two-year yields for the first time since 2007. This kind of inversion between short- and long-term yields is viewed by many as a strong signal that a recession is likely in the future. The S&P 500 closed down 2.9%.
Yet the yield curve is just one signal of economic gloom, and economists can't pinpoint when a recession will follow.
The S&P 500 has weathered such inverted moves before. According to Dow Jones Market Data, the index has gained an average of 2.53% three months after the yield curve first inverted between 1978 and 2005. Six months after the start of these inversions, the broad stock index's gains were an average of 4.87%. A year afterward, the index gained an average of 13.48%. Two and three years out, the S&P rose an average of 14.73% and 16.41%, respectively.
Three months after yields inverted on Dec. 20, 2005, the S&P gained 4.16%. Six months afterward, it was up 1.76%, and a year on it increased 13.62%. Two years later, it was up 18.44%. Three years on, it dropped 28.65% amid the financial crisis.
Sometimes, the S&P 500 has dipped in the short term. When the curve inverted on May 26, 1998, the index was down 0.90% three months later, but six months afterward was up 8.49%. It also fell three and six months after the start of the inversion on Aug. 17, 1978, but a year later was up 3.06%.
The biggest S&P 500 increase three years following the start of an inverted yield curve was tied to a Dec. 9, 1988 inversion. The S&P continued to post gains, and three years later ended 36.54% higher.
Write to Sara Schaefer Munoz at Sara.Munoz@wsj.com