Crash Caused By Yield Curve Inversion And Bank Sector Weakness

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by: Robert Kientz
Summary

The 3 and 5 year treasury rates inverted Tuesday, which caused some sharp selling in the major market indices.

Also bank stocks have shown a lot of weakness YTD, and many bank stocks fell precipitously on Tuesday.

I was surprised at the sharpness of the sell-off considering the good retail numbers from Black Friday and Cyber Monday.

But the computers that run the markets now have the final say on what numbers and news will drive market trading.

Stock Market Crash Photo Credit

Back in July I printed an article talking about the global yield curve inversion which indicated the world was moving into a global recession. However, while the trend of the US 10Y-2Y spread on treasuries has been heading toward an inversion for some time, it hadn't occurred yet.

Today, however, we had our first US yield curve inversion in the 5Y-3Y spread.

US Yield Curve Inversion 5Y-3Y Treasuries Source: CNBC

I believe this caused the computers that run much of the automated trading in the markets to start a sell-off which resulted in the major indices falling about 3% in a single day.

Tuesday Stock Market Crash Source: Yahoo Finance

While the mid-term treasury rates in the 5Y-3Y inverted, the 10Y-2Y rate spread that has preceded 7 of the last 8 recessions has not quite inverted yet. We still have a slight 0.21% difference between the two as I write this article.

10y-2y Treasury Yield Spread Source: Guru Focus

I can only imagine what the computers will do with the markets when that yield curve finally inverts and how much of a sell-off we will get. The SEC's circuit breakers are designed to kick in at 7%, 13%, and 20% sell-offs which may prevent the computers from a truly brutal one day sell-off.

However, much of what goes into algorithmic trading is unknown. At a basic level, the systems sell when markets are down and buy when they are up. But they are much more complicated than that. The major effect is that sell-offs and recoveries seem to happen in faster cycles that humans may not be used to. We will just have to see what happens when that fateful day when the yields between the 10Y and 2Y cross.

Further complicating matters were banking stocks which took a strong beating on the day and indications that the banking sector is now bearish in 2018.

Bank Bruising on Tuesday Source: CNBC and FactSet

Further, banks have not done well so far in 2018. The SPDR® S&P® Regional Banking ETF is down over 7% YTD.

SPDR® S&P® Regional Banking ETF Source: State Street Global Advisors

The question is really whether the positive retail prints during the holiday season will hold up the markets or the debt issues will continue to drag down the banking sector and also cause more sell-offs in the market.

I recap today's action and discuss some strategies for dealing with the increasing market risk in your portfolios in the following video.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.