Using the yield curve to time the stock market

lit the study reported here, we extended the probit model for forecasting all economic recession by using the yield-curve spread as the explanatory variable to forecast a bear stock market and tested market-timing strategies based on the model. We found that the value of the yield spread between the composite 10-year+ U.S. T-bond yield and the three-month T-bill yield holds important information about the probability of a bear stock market. We discuss our out-of-sample market-timing tests at various probability screens of a forthcoming bear market in one month. At a 50 percent probability screen, our simulations show that, for the period studied, a market timer switching out of stocks (T-bills) into T-bills (stocks) one month before a bear (bull) stock market could have realized a compound annual return of 16.46 percent versus 14.17 percent from a stock-only buy-and-hold strategy. This result is economically significant.