Using the U.S. Treasury Yield Curve to Predict S&P 500 Returns and U.S. Recessions

Open Access
Author:
Hanks, Theodore G
Area of Honors:
Finance
Degree:
Bachelor of Science
Document Type:
Thesis
Thesis Supervisors:
  • Jingzhi Huang, Thesis Supervisor
  • James Alan Miles, Honors Advisor
Keywords:
  • U.S. Treasury Yield Curve
  • S&P 500 Returns
  • Yield Curve
  • S&P 500
  • U.S. Recessions
  • Recessions
  • Predicting S&P 500 Returns
  • Predicting Recessions
Abstract:
The goal of this study was to test whether or not the U.S. Treasury yield curve can be used as a predictor of future S&P 500 returns or U.S. recessions. The rationale behind investigating this was that if a relationship was found, it would be very valuable in making investment decisions. A Literature Review was conducted to evaluate previous research, and in general, the results indicated that there was little or no information to support using the U.S. Treasury yield curve as a predictor of future S&P 500 returns, but that there is a strong relationship between the U.S. Treasury yield curve and U.S. Recessions. To test for both of these relationships, data was collected on various Treasury yields as well as S&P 500 price data. The primary way of evaluating whether or not there was a relationship was by using graphical analysis, with some general analysis of the raw data also contributing to the results. Ultimately, the testing revealed that although there is a positive relationship between the yield spreads and S&P 500 returns, the connection was not very strong. On the other hand, after analysis was completed, it was found that there is a very strong relationship between the yield curve and recessions. To summarize, it was found that when the yield spread between a longer-maturity Treasury and a shorter-maturity Treasury is near zero or negative, a recession is likely to occur in the upcoming months. The findings from the study can be used to help make investment decisions. By tracking the U.S. Treasury yield curve, investors can predict when recessions are likely to occur, and can therefore minimize their financial losses from the recession by switching to safer assets during periods when recessions are likely.