From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
Credit spreads are widening to their highest levels since late 2020.
If it feels like we just mentioned spreads and the falling HYG/IEI ratio, it’s because we did – and for good reason! They provide valuable insight into the overall health of the market.
High yield bonds $HYG rolling over faster than US Treasuries $IEI implies stress on credit markets and trouble for equities.
This is critical information.
We’ve been closely following the HYG/IEI ratio for months as it repeatedly tests the lower bounds of its range. It broke down to fresh lows in March, only to bounce higher with many risk assets.
Two months later, this crucial risk ratio is printing fresh 52-week lows again. The main difference is that the overall market environment has drastically changed since the last time we were at these levels.
Even the strongest stocks can’t catch a bid as investors scramble for the exits. Potential support levels are completely ignored as more topping formations resolve lower.
If the grim reaper hasn’t come for the tickers in your portfolio, it’s most likely just a matter of time before he comes knocking.
Here’s a chart overlaying the S&P 500 $SPY and the HYG/IEI ratio:
Notice the difference between the breakdown from a couple of months ago versus the breakdown today.
When credit spreads were widening in March, the S&P 500 held close to its former 2021 lows, ultimately reversing higher. The HYG/IEI ratio followed stocks higher as credit spreads tightened.
Today, both SPY and this key risk ratio are decisively breaking to the downside against a backdrop of broad market weakness.
The largest companies in the world – $AAPL, $MSFT, $GOOGL, & $AMZN – are completing major tops. The median stock measured by the Value Line Geometric Index $VLG is undercutting its former 2018 highs. And we’re losing inflationary stocks and commodity-centric currencies as well.
We couldn’t say these things just a few weeks ago.
With risk appetite falling off a cliff as investors position for defense, we don’t want to fight these trends. Our best bet is to trade small, raise cash, and manage risk before all else.
There will be plenty of time for outsized returns when the market environment becomes more favorable. But we won’t be able to take advantage of those opportunities if our portfolios aren’t intact.
The bond market has spoken. And its message is clear: Stay safe!
Countdown to FOMC
Following the Federal Reserve’s recent rate hike, the market is pricing in a 50-basis-point hike at the June meeting.
Here are the target rate probabilities based on fed funds futures:
This data is from the CME FedWatch Tool as of May 11, 2022.
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