The bond market is sending an amazing signal for stocks

Investors could face additional headwinds from the traditional September weakness. Shares posted their worst weekly performance in over a year amid one of the most significant moves in the bond market since the Covid pandemic.

US stocks, which peaked in mid-July before falling sharply in early August, tried to recapture their all-time highs last month. But they failed to find momentum from either Federal Reserve Chairman Jerome Powell’s Jackson Hole speech or Nvidia’s speech. (NVDA) solid but unspectacular fiscal revenues from the second quarter.

The up-and-down pattern of the past two months has led to concerns about a so-called double top in the S&P 500. A double top occurs when the index hits two recent highs with a moderate decline in between before extending a longer high . withdrawal on time.

Meanwhile, the double-top pattern comes just ahead of the first inversion of the U.S. Treasury yield curve in more than two years, a move many analysts see as a harbinger of recession in the world’s largest economy.

Benchmark 2-year Treasury yields fell below their 10-year counterpart last week and remained lower ahead of Monday’s trading session after the longest reversal on record that began in July 2022.

The bond market is issuing a major warning signal for the US economy heading into the final months of the year.

An inverted yield curve normally indicates recessionary risks, but the recession it predicts does not occur until the yield curve normalizes, with short-term yields falling below long-term yields.

Is a Bull in the Bond Market Rising?

Treasury bond yields, which move in the opposite direction to prices, can reflect both bets on short-term Fed interest rates and speculation about the health of the economy in general.

Lower benchmark 2-year Treasury yields now suggest interest rate cuts at the Federal Reserve, which are expected to begin on September 18 in Washington and continue until early next year.

They are falling, however, faster than long-term yields, which are driven by investors wanting to park money in a risk-free asset in the face of a weakening economy.

This so-called bull tilt is usually associated with Fed easing cycles, but it also played out before recessions in the early 1990s, early 2000s, and right after the 2008 global financial crisis.

The benchmark 2-year notes were last seen trading at 3.708%, compared to 3.761% for the 10-year note.

Related: Surprise jobs report adds case for more Fed rate cuts

“Short-term yields have fallen significantly in all recessions, while longer-term yields have fluctuated, influenced by Fed actions and market expectations of future growth and inflation,” said Althea Spinozzi, Head of Fixed Income Strategy at Saxo Bank .

“In all three scenarios, bonds gained while stocks crashed,” she added, noting that the S&P 500 fell 35.7 percent during the Great Recession from 2007 to 2009, with most of the decline coming amid the Fed’s aggressive interest rate cuts.

The economy is slowing, but no recession yet

The economy, while slowing, remains far from recession. But Friday’s weaker-than-expected August jobs report, which included downward revisions for June and July, suggests a tough road to the end of the year and beyond.

Crude oil prices, which typically reflect global demand tied to economic growth prospects, are trading at their lowest levels in more than a year. WTI futures for October delivery are pegged firmly below $70 a barrel.

But Rick Rieder, BlackRock’s chief investment officer for global fixed income, isn’t buying the recession and says the US economy is “moderation’ and not ‘falling off a cliff’.

Related: The stock market is looking for its lost mojo after a beating

“While the jobs data is clearly softer than what we and the Fed have been used to seeing, it is far from a doomsday indicator of a recession, hard landing, or any pernicious foreshadowing of weakness to come of consumers,” he said.

The bond market’s recent record of predicting recession isn’t stellar either, with the world’s largest economy defying its gloomy forecasts for all of 2022, 2023 and the first half of this year.

Earnings growth remains solid

The Atlanta Fed’s GDPNow forecasting tool suggests a current-quarter growth rate of 2.1 percent, down from the 3 percent pace in the three months ended June, but still far from contraction and recession.

S&P 500 earnings estimates are also holding, with third-quarter profits expected to rise 5.7% from a year ago to $513 billion.

For the full year 2024, profits are forecast to grow 10.2%, more than double from 2023, before rising another 15.4% in 2025, according to LSEG data.

Still, the benchmark S&P 500 fell more than 4.2% this month, dragging it into negative territory for the quarter. And at a price-to-earnings multiple of about 21.2 times, it remains expensive in historical terms, heading for a likely economic slowdown.

Related: Fed rate cut may not guarantee stock market rally in September

Investors are now looking to this week’s August inflation reports, next week’s Fed rate decision and the start of third-quarter earnings season in early October to gauge the market’s outlook for the final months of the year.

A hotter-than-expected inflation reading could solidify bets that the Fed will take its rate-cutting cycle slowly and raise concerns that the economy is beginning to buckle under the stress of high borrowing costs.

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• The CPI report upsets the bet on a big Fed rate cut
• Main Street business is pushing Wall Street into recession

A quiet start to the third-quarter reporting season, which comes just weeks before the November election, could add another layer of caution to an already jittery market.

“After more than two years of obsessing over inflation, the markets have turned a corner,” said Chris Larkin, managing director of trading and investing at E-Trade at Morgan Stanley.

“The first week of September followed seasonal bearish play as weak economic data fueled debate about the possibility of a recession and whether the Fed will cut by 0.25% or 0.5% later this month,” he added .

“But for stock traders and investors, the more immediate concern is volatility. Last week was the biggest week of decline for the S&P 500 since March 2023, and if history is any guide, the ride could continue to be bumpy,” Larkin said.

Related: Veteran fund manager sees world of pain coming for stocks