Credit Spreads

I was reading an article on Zero Hedge about 5 Divergences In The Stock Market To Keep An Eye On This Fall.

With the S&P 500 up nearly 20% and international developed stocks up 13% year-to-date, the markets are having a banner year so far. But, we are squarely in the weakest seasonal months of the year (September and October) and we are starting to see the first signs of divergences between stocks and variables that are related to stock market performance. [...]

So, here are the things we are looking at and will continue to monitor this fall to help ascertain whether 3% dips should be bought or whether a deeper correction is in the offing.

One of the divergences was about something called a credit spread. What is that and why do I care? From Investopedia:

A credit spread is the difference in yield between a U.S. Treasury bond and another debt security of the same maturity but different credit quality. [...]

Credit spreads fluctuations are commonly due to changes in economic conditions (inflation), changes in liquidity, and demand for investment within particular markets.

For example, when faced with uncertain to worsening economic conditions investors tend to flee to the safety of U.S. Treasuries (buying) often at the expense of corporate bonds (selling). This dynamic causes US treasury prices to rise and yields to fall while corporate bond prices fall and yields rise. The widening is reflective of investor concern. This is why credit spreads are often a good barometer of economic health – widening (bad) and narrowing (good).

And let’s go back to the Zero Hedge article:

Finally, while early, credit conditions are no longer improving. Typically, advances in stocks are accompanied by tightening credit spreads in the corporate bond market, since rising stock prices are at least in part a function of improving fundamentals. Yet, corporate credit spreads stopped narrowing in June even as the S&P 500 tacked on another 7%. If spreads take out recent wides, we would view it as a sign that bond investors are starting to get jittery about corporate fundamentals, which is rarely good news for stock prices.

This entry was posted in Uncategorized. Bookmark the permalink.

Comments are closed.