The S&P/ASX 200 (INDEXASX: XJO) index had a day to forget yesterday as the Aussie index fell 2.85% to wipe more than $60 billion off the domestic market.
However, could the recent inversion of the much talked about “recession indicator”, or the 10-year versus 2-year Treasury bond yield spread, actually be a good thing for your portfolio?
Why it’s not all doom and gloom
Before going any further, it is worth noting that the inversion of the 10–2 yield curve has preceded every major recession in history, which on the surface doesn’t look good for investors.
However, the key here is that while a negative spread has been a solid indicator, no one can predict exactly how long after the inversion a recession may occur.
Generally, these recessions have occurred within 24 months of the yield curve inversion, meaning you could have up until August 2021 with solid economic growth before things head south, assuming history repeats itself.
Additionally, markets have historically performed very strongly in the lead-up to some of the biggest recessions we’ve seen, meaning keeping your money in the market may actually benefit you, even with the occurrence of a recession.
As an example, the S&P 500 showed a strong bull run prior to its downturn around November 2007 when the GFC hit, but some panic sellers would have fared better to just keep their money in the market.
If a hypothetical $100,000 in a top growth stock like Afterpay Touch Group Ltd (ASX: APT) surges 60% in the next two years to $160,000, then the market subsequently plummets 30%, that investor is still up $12,000 compared to the guy who exited when the yield curve inverted.
So, while it is true that yield curve inversions haven’t been great for equity investors in the past, in my view it’s a little bit overzealous to think that the market is suddenly going to drop 30% in the next week.
Strong stocks can still perform
Even in historical bear markets, there are the occasional winners that have persevered and protected their downside or even increased marginally.
While not easy to find, the ability to pick a strong, non-cyclical stock such as AGL Energy Ltd (ASX: AGL) in the Energy sector or Woolworths Ltd (ASX: WOW) in Consumer Staples could protect your capital even as other head for the door.
While no one has the crystal ball to predict the future, I’m a firm believer in the old “time in the market” adage, and I’ll be sitting tight in the hope of further capital gains over the next 12–18 months.
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Motley Fool contributor Kenneth Hall has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of AFTERPAY T FPO. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.