Markets Sell Off Amid Rising Recession, Yield Curve Concerns; Bank Stocks Hit Hard

U.S. stocks took a beating Tuesday after the yield on five-year Treasury notes dipped below the yield on three-year and two-year Treasury notes for the first time since 2007. Bank stocks were hit particularly hard, as fears that an inverted yield curve could be signalling a U.S. recession and a difficult earnings environment for financial institutions.

The S&P 500 dropped 3.1 percent (87 points), the Dow Jones Industrial Average dropped 3 percent (791 points) and the PowerShares QQQ Trust, Series 1 QQQ dropped 3.8 percent as investors worried about the possibility of a U.S. recession.

Each of the nine U.S. recessions that have occurred since 1955 came between six months and 24 months after an inversion in the yield curve of two-year and 10-year Treasury yields, according to the San Francisco Fed.

Related Link: What A Yield Curve Inversion Means For Traders

Financials Hammered

Bank investors were hit particularly hard Tuesday. A steeper yield curve helps banks boost their net interest margins, a measure of the difference between the interest rates they pay out on deposits and the ones they charge on loans. Here’s a look at big U.S. bank stocks traded:

• Financial Select Sector SPDR Fund XLF was down 4.3 percent.
• Bank of America Corp BAC fell 5.8 percent.
• Citigroup Inc C fell 4.8 percent.
• JPMorgan Chase & Co. JPM fell 4.2 percent.
• Wells Fargo & Co WFC fell 4.4 percent.
• Deutsche Bank AG DB fell 3.6 percent.
• Morgans Stanley MS fell 5.2 percent.

Investor Sentiment

Aside from Treasury yields, Wall Street analysts have been watching other indicators to gauge the health of the bull market as well.

Investor sentiment, a historically reliable contrarian indicator for the stock market, has been extremely high lately, which Bank of America's Savita Subramanian says is a bearish sign. Bank of America’s Sell Side Indicator hit a seven-year high in November, suggesting investors expect at least 10 percent returns over the next year.

“Whereas this model is based on comparing today’s sentiment levels vs. the long-term average, we have found some evidence that sell signals have higher efficacy relative to shorter histories, which would imply a more bearish outlook,” Subramanian wrote in a Monday note.

Bullish Signals

LPL Financial analyst John Lynch said there are still plenty of bullish indicators for stocks as well. He says U.S. GDP growth of nearly 4 percent over the past two quarters and 28 percent earnings growth from the S&P 500 in the third quarter suggest underlying economic fundamentals are strong. In addition, Lynch said the recent pullback has brought the S&P 500’s PE ratio down to just 15.7, a relatively attractive historical valuation.

“As always, there are risks, but we continue to believe our year-end fair value target range for the S&P 500 of 2900–3000 is achievable” Lynch wrote Monday.

Tuesday’s sell-off brought the S&P 500’s year-to-date return down to just 2 percent with less than four weeks remaining in the year.