One of this week’s most popular posts was “Want An Early Warning When The Cycle Turns? Ask Credit, Not Stocks.”
It consisted of one sentence and two charts:
For those of you interested in getting a heads up before the proverbial sh*t hits the fan, look to credit spreads, because if the last two crashes are any indication, stocks will sleep walk right off the cliff.
Note that a persistent theme here has been the extent to which there’s no room left for credit markets to tighten further. Everything is rich from cash markets, to CDS, to CDX. You might be able to squeeze a few extra bps of compression out of the rally, but that’s going to be about it. In short: credit markets are a rather extreme example of an asymmetric risk/reward scenario in which the deck is definitively stacked against you.
Now then, consider the quote and charts shown above and then see if you notice any eerie parallels with the following commentary out of SocGen.
Via SocGen
We expect the credit market to continue to trade in a range-bound fashion over the near term, supported by solid Q4 earnings reports, but hindered by concerns of potential headwinds on the political front, both domestic and overseas. We had thought that a slowdown of the aggressive January issuance calendar would help enable the markets to grind a bit tighter. However, even with a slower pace for the IG calendar this week (IG: $15bn), credit spreads have continued to be stuck in a very tight range ytd, with IG spreads unchanged at 121bp so far this week and just a modest -2bp ytd. This ‘treading water’ spread action for the credit market is in pretty sharp contrast to an equity market that has been rallying to new all time highs . Equities seem to be more enthused by Q4 earnings (67% of S&P500 have beaten expectations: 235 of 353 companies) and prospects for fiscal stimulus, lower taxes and reduced regulation. Thus far, expectations for a more business-friendly backdrop from the Trump administration has resonated more so with equity investors, and has not been able to translate into much positive momentum for the credit market. Although we do not anticipate a near-term catalyst to jar us out of the current range, we do see a risk for too much complacency.
The previous two cycles did not have massive global QE which are now causing a global credit circle jerk that distorts IG credit spreads. Without that pricing signal one does not know what will come next or when. IMO there will be no leading widening unless the ECB and BOE stop buying corporate credit. The amount of credit spread tightening we have seen the past 12 months would normally signal the end of a recession and beginning of a strong recovery cycle…all without the proper cleansing of a default cycle. Strange days indeed.