Why a yield curve reversal can be good news for this declining stock market sector

The S & P 500 energy sector outperformed the overall market 80% of the time in the 12-month period following the reversals of the yield curve dating back to 1965, say Bank of Canada analysts. America in a research note. In addition, energy stocks beat the S & P 500 by an average of 7.3 percentage points over this period.

If history repeats itself, the group could be directed to a much needed recovery. Energy stocks in the S & P 500 fell 1.2% in 2019, the worst performers in the 11 sectors of the broad-based index, due to a combination of disappointing results and falling commodity prices. oil. In comparison, the overall index is up 15%.

It is unclear, by nature, why a reversal of the yield curve would be linked to above average performance for energy stocks.

According to the conventional wisdom of the markets, short-term bond yields tend to outperform long-term ones before the economy slips into recession. The slowdown in economic growth is generally negative for energy stocks, as businesses and consumers could limit their oil consumption, leading to lower prices. During the fall of the stock market on Wednesday, for example, the energy sector S & P 500 yielded 4.1%, down more than the S & P 500, which lost 2.9%.

But equities do not always behave as investors expected after reversing the yield curve. In fact, the data shows that the market as a whole has tended to increase for several months after a first reversal, in part because the economy generally managed to continue to grow for several months, or even years, before sink into the recession.

"Reverse yield curves in the United States and elsewhere do not tell us much about the timing of future downturns and, for the moment at least, economic data is more consistent with a slowdown than a slowdown in growth. Global economy, "said Simon MacAdam, global economist Capital Economics, said in a note.

Mr. MacAdam added that the delay between a reversal of the yield curve and an economic slowdown varied from a few months to a few years.

According to Bank of America, what could make energy stocks likely to outperform again this time is the fact that they lag behind the S & P 500 for much of the past five years. This has made them ripe for the bargain hunters – although the factors that have kept them under pressure, including slowing global growth and falling oil prices, seem unlikely to dissipate any time soon.

Consider the historical performance of energy stocks as another example of the often counterintuitive movements of markets after the downturn in bond yields in the short and long run.

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Write to Akane Otani at [email protected]