Yield-curve spread as an equity regime filter

One spread from two Treasury yields

The yield curve is reduced to one yield-curve spread: the long-term Treasury yield minus the 13-week Treasury-bill yield. The spread is formed by first viewing the two yields as separate series, then subtracting the daily short-term yield from the daily 30-year yield.

A positive spread is treated as the ordinary state. Long-term holders take more interest-rate and inflation risk than short-term bill holders, so a long yield above the bill yield is the expected shape.

Inversion as an abnormal regime

An inverted yield curve is a negative spread in which short-term yields exceed long-term yields. That state is framed as an abnormal regime in which near-term risk is judged greater than distant risk, often around credit tightening or financial stress.

Inversion episodes listed for recent decades are 1966, 1969-70, 1973-74, 1979-81, and 2000-01. Each episode is described as accompanied or followed by equity bear-market conditions and short-run economic strain.

In the November 1993-February 2006 window, the only inversion began in July 2000 and ran through the first week of January 2001.

Ordinary and abnormal bands in one sample

For a 1993-2006 sample, equity exposure was classified as a moderate-positive regime when the spread sat between 0.00 and +3.00. That moderate-positive band is the ordinary equity-holding regime in the sample. Exposure was classified as an abnormal regime when the spread was negative or wider than +3.00. A positive spread wider than +3.00 is an overstretched positive spread and is grouped with inversion as an abnormal market state.

Those classified paths were then compared with an uninterrupted holding path. Aftereffects of inversion are described as typically lasting a minimum of three months, including time after the spread has already turned positive again. That weeks-to-months interval is the post-inversion window.