Why a yield-curve inversion may be good news for this lagging stock sector

Energy shares have historically outperformed the broader market in the months following a yield-curve inversion.

  • By Akane Otani,
  • The Wall Street Journal
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Last week’s yield-curve inversion might have been a good sign for the stock market’s biggest laggard this year: energy stocks.

The S&P 500 energy sector has outperformed the broader market 80% of the time in the 12-month period following yield-curve inversions going back to 1965, Bank of America analysts said in a research note. What’s more, energy stocks beat the S&P 500 (.SPX) by an average of 7.3 percentage points over that period.

If history repeats itself, the group could be headed for a much-needed turnaround. Energy stocks in the S&P 500 have fallen 1.2% in 2019, posting the worst returns of the broad index’s 11 sectors, because of a combination of disappointing earnings and sliding oil prices. In comparison, the broad index is up 15%.

It isn’t inherently clear why a yield-curve inversion would be linked to better-than-average performance for energy shares.

Conventional market wisdom says shorter-term bond yields tend to exceed longer-term ones before the economy slips into recession. Slowing economic growth is typically negative for energy shares, since businesses and consumers might curb their consumption of oil, pushing prices lower. During the stock market’s tumble Wednesday, for instance, the S&P 500 energy sector shed 4.1%—declining more than the S&P 500, which lost 2.9%.

But stocks don’t always behave the way investors expect them to after the yield curve inverts. In fact, data show that the market as a whole has tended to rise for several months after an initial inversion—partially because the economy has typically managed to keep growing for several months, and sometimes years, before actually slipping into recession.

“Inverted yield curves in the U.S. and elsewhere tell us very little about the timing of future downturns and, for now at least, the economic data are more consistent with a slowdown than a downturn in the world economy,” Simon MacAdam, global economist at Capital Economics, said in a note.

Mr. MacAdam added that the lag time between a yield-curve inversion and an economic downturn has in the past been anywhere from a few months to years.

What could make energy stocks likely to outperform again this time around, Bank of America says, is the fact that they have lagged behind the S&P 500 for much of the past five years. That has made them ripe for bargain-hunters—although the factors that have kept them under pressure, including slowing global growth and tumbling oil prices, look unlikely to dissipate anytime soon.

Consider energy stocks’ historical performance another example of the often counterintuitive ways that markets move after short- and long-term bond yields flip.

Conventional market wisdom says shorter-term bond yields tend to exceed longer-term ones before the economy slips into recession. Slowing economic growth is typically negative for energy shares, since businesses and consumers might curb their consumption of oil, pushing prices lower. During the stock market’s tumble Wednesday, for instance, the S&P 500 energy sector shed 4.1%—declining more than the S&P 500, which lost 2.9%.

But stocks don’t always behave the way investors expect them to after the yield curve inverts. In fact, data show that the market as a whole has tended to rise for several months after an initial inversion—partially because the economy has typically managed to keep growing for several months, and sometimes years, before actually slipping into recession.

“Inverted yield curves in the U.S. and elsewhere tell us very little about the timing of future downturns and, for now at least, the economic data are more consistent with a slowdown than a downturn in the world economy,” Simon MacAdam, global economist at Capital Economics, said in a note.

Mr. MacAdam added that the lag time between a yield-curve inversion and an economic downturn has in the past been anywhere from a few months to years.

What could make energy stocks likely to outperform again this time around, Bank of America says, is the fact that they have lagged behind the S&P 500 for much of the past five years. That has made them ripe for bargain-hunters—although the factors that have kept them under pressure, including slowing global growth and tumbling oil prices, look unlikely to dissipate anytime soon.

Consider energy stocks’ historical performance another example of the often counterintuitive ways that markets move after short- and long-term bond yields flip.

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