I have been trying to study and look at historical yield spreads to see how helpful they can be in describing risk and predicting market tops. For now I’ve just been downloading the historical data and manipulating it a bit in a spreadsheet, but I will try to see if there are any academic papers out there on the subject. For now, here is one of the charts I’ve created with various yield spreads and the S&P 500 price (click for larger view):
As you can just tell by looking at the chart, when spreads like the 10 year and the 3 month and the 2 year and the 3 month become zero or negative, you should be looking out for a market top as this seems to signal that there is no longer a risk premium (I think that’s the correct way to describe it). There is no fool proof way to predict tops or bottoms, but I think looking at such things as the yield curve should is a very worthwhile thing to do, for when the yield curve flattens out or inverts, that is usually a sure sign that things are getting silly.
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