ROSENBERG: My favorite predictive tool nailed what happened in 1987

It’s the 28th anniversary of Black Monday, when in 1987, the Dow had its worst day ever and plunged 22.6%.

Surprisingly, for at least another four years from Black Monday, there was no recession or bear market.

One thing that could have signaled impending doom was an inverted yield curve. This rarity occurs when short-term interest rates (like the yield on the three-month treasury bill) become higher than long-term interest rates (like the yield on the 10-year treasury note).

Conventionally, an inverted yield curve is a sign of a looming recession, and has presented itself before every recent recession.

But Gluskin Sheff’s David Rosenberg pointed out in a client note Monday that the yield curve remained positively sloped then. It’s still positively sloped now (although it’s possible it can invert even with short-term interest rates near zero as they are today), and Rosenberg said he would use it as a forecasting tool today:

He wrote,

If I were alone on a desert island, as some people probably wish I was, and I had one tool in the kit to use for predictive purposes, it would be the yield curve.

Back in that antsy period in 1987, the one thing that did not happen was that the yield curve did not invert (as it did in 2007!), it remained positively sloped as it is today (and likely to stay that way with the Fed standing pat – though I do see Economists Expect Fed Rate Rise This Year on page 13 of today’s FT), and as such provided the signal that the expansion and bull market had more years to run (three to be exact).

No bull market or economic cycle ends “on its own,” Rosenberg has said. “It ends in a liquidity cycle when the Fed tightens so dramatically that it inverts the yield curve.”

Gluskin Sheff