The ‘Sinister’ Credit Canary

Is credit the canary?

Honestly, I don’t know anymore. Up is down and down is up, and what’s down sharply one day is liable to be up dramatically the next. Employers either shed 300,000 jobs in January or they added 400,000.

We used to cringe when crypto crashed because we feared “the coins” might spill over into our wholly respectable mega-cap US tech stocks. Now, crypto cringes at every gyration in Nasdaq futures. “The stocks” are more unreliable than make-believe internet money — Facebook, Netflix, Twitter, PayPal, Zoom and Peloton have all suffered crypto-esque crashes.

Spreads were relatively well-behaved in January, a wholly unfortunate month for equities, leading many to suggest that until there were signs of significant stress in credit, the Fed had carte blanche to tighten the screws. But then again, BBs had their worst month outside of WorldCom, 9/11, the GFC and the initial COVID shock (figure below).

“Credit leads equities,” BofA’s Michael Hartnett said, in his latest, calling the price action in corporate bonds “sinister.”

Although stocks have seen “no capitulation” on the flows side (or at least not in aggregate), more than $10 billion fled IG and high yield over the latest weekly reporting period.

That, Hartnett remarked, was the ninth-largest weekly outflow since 2003. If past is precedent, that doesn’t bode well for equities.

The figure (above) suggests the combination of outflows from high yield and large inflows to equities “signaled big tops” in the past, as BofA put it.

Notably, Lipper data shows outflows from high yield have accelerated materially over the past several weeks, including more than $4 billion in the week to February 2 (figure below).

In the same note cited above, BofA’s Hartnett flagged a big leap in volume in the junk ETF. The 30-DMA for HYG volume is the highest since the tumult surrounding the onset of the pandemic.

Meanwhile, in another foreboding development, CDX.IG is the widest in 15 months. “While corporate credit generally has held up well in the face of broader volatility, the rising credit risk gauge indicate[s] greater investor interest in hedging,” Bloomberg said, pointing to an increase in credit derivative volumes.

Global investors “are starting to price in looming interest-rate hikes amid questions about the debt-servicing capacity of highly leveraged corporates,” the linked article noted.