If we see a yield curve inversion, what does that mean for stocks? … checking in on the recent “death cross” … where Eric Fry is finding massive yields for subscribers today

In recent Digests, we’ve been highlighting the potential for an inversion of the 10-year Treasury yield and the two-year Treasury yield.

Historically, such an event would be a strong indicator of a coming recession. As we pointed out yesterday, an inverted 10/2 curve has preceded the last eight recessions. If we go further back in time, the inversion has preceded 10 out of the last 13 recessions.

(If you need a general refresher on yield curves and inversions, click here.)

As you can see below, we’re getting closer to such an inversion (which would mean we reach a reading of “0”), but as I write Friday morning, there’s still a spread of 20 basis points.

But let’s say that things continue along this downward trajectory and these yields invert in the coming weeks.

If a recession does follow, when might it happen? And what would that mean for your portfolio?

Earlier this week, our technical experts, John Jagerson and Wade Hansen, of Strategic Trader shed more light on these questions. What they found supports our broad stance on the market today – big-picture defense, yet localized pockets of offense.

Let’s get into some details.

***What’s the lag time between a yield-curve inversion and a recession?

For newer Digest readers, Strategic Trader is InvestorPlace’s premier trading service. It combines options, insightful technical and fundamental analysis, and market history to trade the markets, whether they’re up, down, or sideways.

In Wednesday’s update, John and Wade looked at three recent yield-curve inversions and the related timing of a subsequent recession.

From their update:

The important thing to notice here is how long it has taken for the recession to begin after the yield curve first inverted…

• When the yield curve inverted in Jun. 1998, it took until Mar. 2001 for the recession to start.
• When the yield curve inverted in Dec. 2005, it took until Dec. 2007.
• When the yield curve inverted in Aug. 2019, it took until Feb. 2020 (and that was accelerated by COVID).

You can see how these dates line up with the performance of the S&P 500 in the monthly chart of the index in Fig. 2 (black line = first inversion; red line = start of recession).

Source: TradingView

Fig. 2 – Monthly Chart of the S&P 500 (SPX)

As you can see, the S&P 500 continued to rise into the recession in each case after the initial inversion.

I took John and Wade’s research and averaged the lag times between inversion and recession. The numbers shake out to a period of 21 months.

So, obviously, an inversion doesn’t necessitate an urgent response in your portfolio.

Also, John and Wade pointed out that in each of these past inversions, the stock market continued to climb until the recession hit.

What were those specifics?

I went back and crunched the numbers. In John and Wade’s examples, the average gain of the S&P 500 between an inversion and a recession comes in at 14.7%.

Here are the details:

Between June of ’98 and March of ’01, the S&P climbed 14%.

Between December of ’05 and December of ’07, the S&P tacked on 18%.

And between August of ’19 and February of ’20, the S&P added 12%.

As you can see, the sky does not immediately fall after an inversion – which, remember, hasn’t even happened yet.

Here’s John and Wade’s bottom line:

Are there myriad risks in the market right now?

Yes. But there are still plenty of bullish trading opportunities, and we plan to take full advantage of them.

That’s what we’ve been doing as well here in the Digest. In recent days, we’ve highlighted specific opportunities in oil stocks, commodities, and hypergrowth sectors including cybersecurity.

In a moment, we’ll highlight one more.

***First, speaking of market risk, let’s circle back to an important indicator we highlighted last week to check its status

In our March 3rd Digest we profiled “simple moving averages” (SMAs).

We noted that the S&P 500 was approaching a situation in which the 50-day SMA would fall through the 200-day SMA. This is something that technical investors call a “death cross.”

We pointed out that over the last 10 years, every time the 50-day SMA has fallen through the 200-day SMA, the S&P has seen a substantial pullback. The exception is the 2020 bear market, which happened so fast (while the recovery was equally fast) that these moving averages didn’t cross until the stock market damage was already in the rearview mirror.

Last week, this death crossed occurred. However, the markets have pushed higher in the subsequent days.

You can see how this looks below. The blue line is the 50-day SMA and the red line is the 200-day SMA.

As you can see, the S&P has just poked north through the 200-day SMA.

The critical question is “will the 200-day SMA turn into a ceiling or a floor?”

Below, we’ll look again at this chart with two elements highlighted.

Notice that the recent move north is a drastic break from the multi-month downward trend line of the S&P.

So, is this bullishness a genuine trend reversal and the start of sustained gains?

Or is it a head-fake? A fleeting relief rally that will fizzle out as the bears resume control?

What makes the answer difficult is that the recent gains we’ve enjoyed have not been gradual and tested by small pullbacks. It’s just been an explosive, sudden burst north.

It’s easier to feel confident about a true market reversal when you see a gradual bottoming-out process, followed by some small moves north that are tested and hold, followed by a series of higher highs and higher lows.

All we have now is a massive move north. That doesn’t mean this gain can’t hold. It just means it hasn’t been tested yet.

We’ll be monitoring this. But the higher the S&P moves above its 200-day SMA, the better.

In the meantime, what if you could make money regardless of how this plays out?

On that note, let’s turn to a narrower part of the market that appears poised for continued bullishness irrespective of the S&P.

***This oil-related trade is offering huge yields

Regular Digest readers know that our macro specialist, Eric Fry, recently led his Speculator subscribers to a 100% gain on a portion of their oil trade.

In his other newsletter, Investment Report, Eric just recommended several new oil-related trades. But this time, he’s zeroing in on a specific type of high-yield investment.

After pointing out how the broad U.S. oil and gas sector has a healthy tailwind behind it today, Eric pivots to the new opportunity:

Elsewhere in the energy sector, a different sort of investment opportunity is also emerging: midstream energy partnerships.

Although these quirky stocks do not possess the stock-price firepower of most E&P stocks, they do possess the firepower to pay very high dividend yields. And now that oil and gas prices are soaring, midstream companies are starting to boost their dividend payments once again.

To generalize, midstream limited partnerships are publicly traded partnerships that own and operate a collection of income-generating assets like oil and gas pipelines and storage facilities.

Often, some or all of the dividends these partnerships pay receive favorable tax treatment as a “return of capital,” rather than a typical income-based dividend.

To get a general idea of this corner of the market, we can look at the Alerian MLP ETF, AMLP. It holds some of the biggest midstream energy partnerships, including Magellan, Enterprise, and Energy Transfer.

As I write, the distribution yield of AMLP is 7.75%. This is on top of its year-to-date performance of 18%.

Eric just recommended three specific midstream plays. Their collective distribution yield comes in even higher, at 8.1%. And their average gain on the year is north of 20%.

Here were Eric’s criteria for these picks:

Each of them…

• Operates midstream assets in the main oil-producing regions of the U.S.;
• Possesses unique opportunities for growth;
• And pays a dividend of more than 7.3% that is likely to grow over the next couple of years.

To learn more as a subscriber, click here. At a minimum, if you’re looking for a high-yielding asset with macroeconomic tailwinds behind it, look into these midstream companies.

Have a good evening,

Jeff Remsburg