High-Yield Hangs Tough as Credit Spreads Hold

From the Desk of Ian Culley @Ianculley

If you can pry your eyes from the UK gilt and Credit Suisse articles, you’ll find it’s not all doom and gloom across the bond market – especially high-yield debt in the US.

A quick warning before we continue: You probably won’t see a similar message on the financial news. It’s just too optimistic for the current environment. It wouldn't get enough clicks.

But facts are facts. And right now, high-yield bonds are hooking higher, while stocks are also rising.

Check out the dual-pane chart of the Fallen Angel High-Yield Bond ETF $ANGL and the S&P 500 $SPX: 

ANGL tends to bottom with the S&P 500 at significant turning points. That’s because high-yield bonds are risk assets more akin to small-caps than investment-grade debt or Treasury bonds. 

A sustained breakdown in ANGL implies growing risk aversion among investors. But that’s not what we’re witnessing. 

Instead, it’s reclaiming its June pivot lows. No red flags here! 

With high-yield bonds failing to roll over, it’s no surprise credit spreads aren’t blowing out like the UK-German sovereign spread did last week.

Here’s a chart of the S&P 500 ETF $SPY overlaid with the high-yield credit spread ratio $HYG/$IEI:

Notice the HYG/IEI ratio made a higher lower while SPY broke down.

The bullish divergence from this critical risk ratio was a poignant heads-up that investors were still reaching for risk, resulting in a quick upside reversal for both.

According to high-yield bonds, US credit markets aren't under stress. They’re no doubt oversold, but they're not on the verge of dysfunction.

Despite the lack of concern from credit spreads, last week’s message still applies:

Don’t try to pick the bottom…focus on risk management and protecting capital. 

To be clear, the latter always applies! Risk management is job No. 1.

Let’s add a caveat: We don’t want to make the bet that stocks resolve lower while investors support a bid in high-yield debt.

As long as high-yield bonds hang tough and credit spreads don’t blow out, messy market conditions are likely in the early stages of an accumulation phase.

Regardless, we’re not picking a bottom in the major averages. But that’s not going to stop us from finding stocks we want to buy.

Stay tuned.

Countdown to FOMC

Following the Fed's 75-basis-point increase last week, the market is pricing in a double-hike in November.

Here are the target rate probabilities based on fed funds futures:

Click the table to enlarge the view.

This data is from the CME FedWatch Tool as of October 6, 2022.

Thanks for reading. And please let us know what you think.

As always, be sure to download this week’s Bond Report!