Just two days ago we warned of the dramatic disconnect between equity insurance and credit insurance markets - at levels last seen before Bear Stearns collapse. As the Yuan devaluation shuddered EURCNH carry traders and battered European assets, US equity markets stumbled onwards and upwards, impregnable in their fortitude with The Fed at their back no matter what. However, US corporate bond markets were a bloodbath...
The Bank of America/Merrill Lynch High Yield CCC Yield got absolutely slammed this week, rising from 13.58% to 16.18%! The biggest spike in yields since the financial crisis.
That would suggest, as all listed above, that there has been inordinate and tremendous “dollar” pressure not in foreign, irrelevant locales but creeping into the contours of the domestic and internal framework.
And while the junkiest of the junk saw the biggest decompression since Lehman, the rest of the high yield bond market is also starting to catch the credit cold..
Of course, some of this is energy related which has blown wider to record wides... (once again equity just totally ignoring the carnage)...
But it's not all energy.
And as we noted previously, BofA points out that in just the past two weeks, credit spreads from our HG corporate bond index have widened another 9bps to 164bps while equity volatility is down another percentage point (although technically BofA uses the 3rd VIX futures as its measure of equity volatility rather than VIX itself to get a smoother series that is less affected by the daily noises and seasonalities).
This is how the resulting dramatic divergence looks like:
Why is this notable?
In BofA's own words: "this spread currently translates into 10.26 bps of credit spread per point of equity vol, the level reached on March 6, 2008 – ten days before Bear Stearns was forced to sell itself to JP Morgan for $2/sh. Recall that – unlike the credit market – the equity market well into 2008 was very complacent about the subprime crisis that led to a full blown financial crisis."
In other words: unprecedented equity complacency matched by a state of near bond market panic.
The key reason for this weakness is that our market has transitioned from “too much money chasing too few bonds” to “too many bonds chasing too little money”. That shift is motivated by the impending Fed rate hiking cycle as issuance, M&A and other shareholder friendly activity has been accelerated while at the same time demand has declined. Again, we are not trying to predict a crisis – only to point out that the upcoming rate hiking cycle appears to concern issuers and investors so much that they have been taking real actions that have repriced our market lower relative to equities to an extent that we have only seen during the financial crisis.
We can't wait to find if this is the first time in the history of capital markets when it is stocks that are right, and bonds wrong.
The cumulative assessment of all these factors, great as they are in their individuality, is that the global financial system just endured this week another “dollar” run. We can say with some reasonable assurance there was one in early December, as well as one centered on October 15.
They seem to be increasing in intensity and now reach, penetrating deeper into the bowels of the “dollar” system as well as taking down central banks with each successive wave.
We have, of course, seen this picture before (most egregiously in 2007/8) and as Bloomberg calculates over 70% of the time since 1996, as spreads widened as much as they have since April, the S&P 500 has fallen, with the average decline exceeding 10%.
History may not repeat but it sure does rhyme...
Charts: Bloomberg, Alhambra Investment Partners