Monthly Market Report: Monitoring Yield Spreads and S&P 500 Performance

Develop a comprehensive market report analyzing the dynamics between the US Treasury Yield Spread (10-Year vs. 3-Month) and the S&P 500 Index performance from 1990 to the present. The report will offer valuable insights into the relationship between interest rate trends and equity market movements, emphasizing yield spread behavior (normal to inverted curves) and cumulative stress loss in equities.

The 10Y-3M Yield Spread as a Leading Economic Indicator

The US Treasury Yield Spread, calculated as the difference between the 10-Year and 3-Month Treasury yields, is widely regarded as a reliable indicator of macroeconomic conditions—highlighting the relationship between long-term growth expectations and near-term monetary policy. Historically:

• A positive spread (normal curve) suggests healthy economic growth expectations, as long-term rates exceed short-term rates.

• A negative spread (inverted curve) has predicted every US recession since 1960, typically 6 to 24 months before the downturn, reflecting expectations of slower growth and potential monetary easing. The Federal Reserve even incorporates this spread into its recession forecasting models.

This spread encapsulates investor sentiment regarding near-term monetary policy (captured by the 3-month T-bill) and long-term growth and inflation expectations (captured by the 10-year Treasury bond).

The report should be structured over 4 pages, and it should consist of the following:

Page 1: 10Y3M Yield Spread and SnP 500 Performance

Present the profile of the US Treasury 10-Year vs. 3-Month Yield Spread and the SnP 500 Rolling Maximum Loss through historical analysis.

Market Commentary:

• Focus on the significance of the 10Y-3M Yield Spread as a measure of economic health, with high relevance to long-term and short-term interest rate gaps.

  
  

• Examine the S&P 500 Rolling Maximum Loss as a metric for cumulative stress loss, highlighting how fluctuations in both indicators have historically aligned or diverged.

  
  

• Include insights on current spread levels and price levels, with a review of historical highs/lows and what these suggest for strategic positioning in the bond and/or equity markets.

Market Data for Interest Rates:

https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value=2023 

for SnP 500 Index data, use the "yfinance" Python library.

Page 2: 10Y3M Yield Spread: Normal and Inversions

Feature a table detailing the minimum yield spread. The yield spread is calculated using the formula:

10Y3M Yield Spread = 10Y US Treasury Rate - 3M US Treasury Rate.

The table should be clearly visible, represent normals/inversions for each month from 1990 to the present, and include information such as the date of the maximum and minimum yield spread and their respective values.

Page 2: 10Y3M Yield Spread Analysis: Normals and Inversions

Present a table illustrating the monthly minimum 10Y-3M Yield Spread from 1990 onward.

Calculate yield spread using:

10Y3M Yield Spread = 10Y US Treasury Rate − 3M US Treasury Rate

The table should clearly highlight periods of normal versus inverted yield spreads, listing the date of each maximum and minimum yield spread along with corresponding values.

Page 3: SnP 500 Performance: Cumulative Losses

A table detailing the SnP 500’s monthly cumulative losses from 1990 to the present.

Include a table illustrating the minimum cumulative loss of the S&P 500. The table should represent cumulative losses for each month from 1990 to the present and provide information about the date and value of the maximum cumulative loss.

Page 4: SnP 500 Performance: Maximum Drawdown

A table detailing maximum monthly drawdown levels for the SnP 500 from 1990 to the present.

Include a table illustrating the maximum drawdown. This table should indicate the maximum drawdown levels for each month from 1990 to the present and provide information about the date and value of the maximum drawdown.

General Guidelines:

Each table and chart must be clearly labeled and easy to read. The report should be updated on the current date. Include a relevant chart of the US Treasury 10Y-3M Yield Spread and the S&P 500 Equity Market Index. Discuss the dynamics of the US Treasury Yield Spread & S&P 500 Equity Market, and provide the commentaries.

Market Report: US Treasury Yield Spread & S&P 500 Equity Market Dynamics

Updated on 2023-09-19 US Treasury 10Y-3M Spread The US Treasury 10Y-3M spread is a crucial indicator of the difference between long-term and short-term interest rates. It is widely used as an indicator to study curve inversion levels. A 10Y-3M spread that approaches 0 signifies a 'flattening' yield curve. Furthermore, a negative 10Y-3M spread has historically been viewed as a predictor of a recessionary period. It has predicted every recession from 1990 to 2023 but has occurred 6 to 24 months before the recession occurring, and is thus seen as a far-leading indicator. The Fed uses the spread in a model to predict recessions 6 - 24 months ahead. As of 2023-09-19, the current spread stands at -117 basis points. It has historically oscillated between a maximum of 387 basis points on 1992-05-04 and a minimum of -189 basis points on 2023-06-01. The current spread level of -117 basis points falls below the long-term mean-reversion level, indicating a potential signal and suggesting taking a long position on the USD 10Y3M spread.

When a trader anticipates that the spread (in this case, the 10Y3M yield spread) is significantly below its long-term mean and expects it to increase (normalization), the trader might consider taking a "long position" on the spread itself using interest rate swaps, futures, or structured trades. A "long position" in this context means that the trader is betting that the spread will increase. The objective is to profit from the anticipated rise in the 10Y-3M spread.

Note: Taking a “long position” on the spread does not mean going long on the 10Y Treasury alone; it means betting on the widening of the yield spread using appropriate instruments.

Inverted Yield Curve Periods: 2000 (Dot-Com Crash), 2006–2007 (Global Financial Crisis), 2019 (Pre-COVID Slowdown), 2022 (Tightening Cycle). Each of these periods saw a yield curve inversion followed by equity market stress or correction within 6 to 18 months. Periods like 2003–2006 and 2010–2018 showed steep positive spreads, corresponding with strong equity bull markets and broad economic expansion.

Note: A positive yield spread (10Y > 3M) indicates that long-term interest rates are higher than short-term interest rates, while a negative yield spread (10Y < 3M) indicates that short-term interest rates are higher than long-term rates. S&P 500 Equity Market Index The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices.

Maximum Cumulative Losses

As of 2023-09-19, the current price stands at 4443.95. During the period from 1990 to 2023, it reached its highest at 4796.56 on 2022-01-03 and its lowest at 295.46 on 1990-10-11. Over the period, the index hit its highest return at 11.58% on 2008-10-13 and its lowest return at -11.98% on 2020-03-16, experienced a cumulative loss of -52.58% on 2009-05-19 with the maximum drawdown in the S&P 500 during the same period was -56.78%.

Note: The period runs from 1990 to 2023, totaling 8494 business days.

Consolidated Market Report As of 2023-09-19, the US Treasury 10Y-3M spread stands at -117 basis points, well below its long-term mean-reversion level of 159 basis points. This negative spread, which differentiates the long-term from short-term interest rates, has historically foreshadowed economic downturns, typically forecasting recessions 6 to 24 months in advance. Given that the spread reached its lowest at -189 basis points recently on 2023-06-01, and juxtaposed with the S&P 500's performance - peaking at 4796.56 in 2022 and dipping as low as 295.46 in 1990, the current market scenario suggests heightened caution.

Maximum Drawdown

When combined with yield spread signals, drawdown analysis offers a composite view of systemic risk across fixed income and equities.

The equity market, while robust in its recent performance with the S&P 500 priced at 4443.95, might be poised for a re-evaluation in the face of these leading indicators. Investors might consider re-strategizing their positions, especially with the spread signaling a potential long stance on the USD10Y3M.

The chart above illustrates the time series of the 10Y-3M Yield Spread alongside the S&P 500 Rolling Maximum Loss from 1990 to 2024. The figure considers the US Treasury 10Y3M rates spread, expressed in percentage, and the time-series of the SnP 500 prices. The period runs from 1990-01-02 to 2023-09-19, totaling 8494 business days. If required, the missing rates with maturities are calibrated using an appropriate yield curve construction model with a 30/360 day count convention.

• Inverted Yield Curve Periods (2000, 2006-07, 2019, and 2022): Each inversion preceded a significant drawdown in equities within 6–18 months. for example, the 2000 Dot-Com Crash, the 2008 Global Financial Crisis, and the 2020 COVID Crash.

  
  

• Normal Yield Curve Phases: Periods of steep positive spreads often coincided with equity bull markets (2003–2006 and 2010–2018).

  
  

• Current (2024) Yield Spread Levels: As of March 2024, the 10Y-3M spread remains deeply inverted, with the 3-month yield higher than the 10-year yield by nearly 150 basis points. Historically, such deep inversions have persisted only temporarily before sharp rate adjustments or equity volatility events.

  
  

• S&P 500 Price Levels: The index has recently reached new all-time highs but with increasing fragility as macro tightening and persistent inflation fears weigh on valuations.

  
  

• Bond Market Implication: A persistently inverted curve may suggest overly tight monetary policy, offering long-duration bonds an opportunity to benefit from future rate cuts.

  
  

• Equity Market Implication: Investors should be cautious of late-cycle risk, particularly in overvalued sectors. Rolling maximum losses tend to increase after inversions reverse, signaling a possible lagged equity correction.

  
  

• Cross-Asset Signal: The combination of an inverted yield spread and growing cumulative losses in equities serves as a powerful risk-off signal, calling for heightened vigilance in portfolio positioning.

Disclaimer: This report is for educational and informational purposes only. It does not constitute investment advice, recommendation, or an offer to buy or sell any financial instruments.

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Additional Requirements:

The analysis exhibits an interesting correlation between the US Treasury 10Y-3M Yield Spread and the S&P 500 Equity Market Index. Historically, periods of yield spread inversion have often been associated with specific patterns in the equity market. When the yield spread inverts, it has historically been regarded as a leading indicator of an impending economic downturn. The equity market's reaction to such occurrences has typically been mixed, with heightened uncertainty leading to increased market volatility. Yield spread inversions have the potential to influence investor sentiment and decision-making. During inversion periods, risk-averse investors may adopt a cautious approach, leading to a reduced appetite for equities and potential shifts toward safer assets.

• Correlation Analysis: Calculate the correlation coefficient between the yield spread (e.g., US Treasury 10Y-3M yield spread) and the equity index (e.g., S&P 500). A positive correlation indicates that both move in the same direction, while a negative correlation suggests an inverse relationship. This can give insights into how changes in the yield spread relate to movements in the equity market.

  
  

• Cross-Correlation and Lag Analysis: Examine cross-correlation between the yield spread and equity index at different time lags. This analysis can reveal any time-delays or lead-lag relationships between changes in the yield spread and subsequent movements in the equity market.

  
  

• Volatility Analysis: Analyze the volatility of both the yield spread and equity index over the same time frame. High volatility in the yield spread during periods of equity market uncertainty might indicate heightened market sensitivity to interest rate changes.

  
  

• Rolling Regression Analysis: Conduct a rolling regression between the yield spread and equity index returns over time. This analysis can help identify any time-varying relationships between the two variables and how they might evolve during different market conditions.

  
  

• Regime Switching Models: Employ regime-switching models to identify distinct market regimes characterized by different relationships between the yield spread and equity index. This analysis can uncover shifts in the relationship during various market phases.

  
  

• Granger Causality Test: Perform Granger causality tests to assess whether the yield spread "Granger causes" changes in the equity index or vice versa. This can help identify whether one variable can predict movements in the other.

  
  

• Event Study Analysis: Conduct an event study analysis to examine how significant macroeconomic events, such as changes in central bank policies or economic indicators, impact both the yield spread and equity market.

  
  

• Rolling Correlation and Moving Averages: Calculate rolling correlations between the yield spread and equity index returns using moving windows of data. This can reveal short-term and long-term relationships between the two variables.

  
  

• Divergence Analysis: Analyze periods of divergence between the yield spread and equity index movements. Investigate the potential reasons behind such divergence and how the market may react in such situations.

  
  

• Frequency Domain Analysis: Apply frequency domain analysis (e.g., wavelet analysis) to understand the cyclical patterns and harmonics between the yield spread and equity index. These calculations can offer valuable insights into the relationship between the yield spread and the equity index and provide a more comprehensive understanding of how changes in interest rates impact the stock market. Remember that financial analysis is often iterative, and combining multiple methods can provide a more robust view of the dynamics between these two critical variables.