Credit spreads have tightened a good deal since October.
I can’t help but think this is just more classic bull market behavior.
As the major US equity indices have been rallying into year end, we’ve seen confirmation out of a number of credit ratios we track to gauge risk appetite within fixed income markets. Specifically, the the iShares High Yield Corporate Bond ETF $HYG is trading at 52-week highs relative to the iShares 3-7yr Treasury Bond ETF $IEI.
This ratio ultimately gives us an inverted chart of credit spreads. Check it out:
Notice how both the S&P 500 and the HYG/IEI ratio are pressing back through their summer highs.
It’s hard to have a bull market in equities if the bond market is positioning defensively. Think about it; the players in the market with the deepest pockets require an incredible amount of liquidity.
And they’re not going to get that liquidity in small-cap stocks.
And most of the time, they’re not even getting enough in large-caps.
So they need to resort to the largest and deepest market on the planet: the bond market.
If institutions are derisking their credit portfolios, chances are they’re going to need to sell their riskier assets as a source of funds. So, by that extension, tracking credit spreads is one of the most important elements of our process when gauging either the severity of a market sell-off or the degree to which credit markets are confirming new highs in equities.
Right now, HYG/IEI is supportive of new highs from the S&P 500.
It’s classic bull market behavior.