Yield Curve as a Stock Market Indicator

Conventional wisdom holds that a steep yield curve (U.S. Treasuries term spread) is good for stocks, while a flat/inverted curve is bad. Is this wisdom correct and exploitable? To investigate, we consider in-sample tests of the relationships between several yield curve metrics and future U.S. stock market returns and two out-of-sample signal-based tests. Using average monthly yields for 3-month Treasuries (T-bill), 1-year Treasuries, 3-year Treasuries, 5-year Treasuries, 10-year Treasuries (T-note) and 20-year Treasuries as available during April 1953 through June 2012, monthly levels of the S&P 500 Index during March 1953 through July 2012 and monthly values of SPDR S&P 500 (SPY) during January 1993 through July 2012, we find that: (more…)