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One very valuable tool for determining where we are in the economic cycle is the 10-Year/2-Year U.S. Treasury yield spread. To create this chart (see chart below), the current two-year Treasury note yield is subtracted from the current ten-year Treasury note yield and plotted over time. When the spread is between 0 percent and 1 percent, it is in the “recession warning zone” because it signifies that the economic cycle is reaching maturity and that a recession is likely to occur within a few years. When the spread falls into negative territory, that’s when the yield curve is inverted, which means that a recession is imminent within the next year or so. The yield curve inverted before every U.S. recession in the past half-century, which is why it is worth paying close attention to. (Read my piece about the Treasury yield spread to learn more.)

According to the 10-Year/2-Year U.S. Treasury bond spread, we are currently in the “recession warning zone,” but not the “recession zone” just yet.At the rate the yield curve is currently flattening, the yield curve may actually invert as soon as late-2018. According to my research, during the last six economic cycles that culminated in a recession, an average of 9.7 months elapsed between the time that the yield curve first inverted and the peak of the stock market. Recessions began an average of 5 months after the stock market peaked or 14.7 months after the yield curve inverted. According to this logic, if the current cycle follows the average of the past six cycles, the yield curve would invert in December 2018, the stock market would peak in September 2019, and the recession would begin in February 2020.

The CBOE Volatility Index or VIX is a popular fear gauge that is derived from the sentiment of stock option traders. The VIX is usually viewed in a contrarian manner: when fear is very high (typically over 30 to 40), it is often a good time to buy stocks. When fear is very low (usually under 20), however, it is a sign of dangerous market complacency or even euphoria that tends to occur during a bubble. The VIX often remains in complacency territory for a long time before the stock bull market or bubble ends.