Credit instruments, like high yield bonds, are positively correlated to equities. Until late June of 2014, the iShares iBoxx USD High Yield Corporate Bond ETF: HYG tracked the trend of the S&P 500 in both slope and duration. Since June, high yield bond prices and credit spreads have signaled increasing distress in the credit markets. Thus far, the concern signaled in the high yield credit markets is more pronounced than that of U.S. equities. In fact, if the S&P 500 were to continue tracking the high yield bond market, it would need to close the gap seen in the chart below and pull back from 1978 to about 1850 on the index, a 6.5% correction.
From our perspective, recession risk is low and upward pressure on interest rates is only modest. To us, this suggests that credit defaults should remain quiet and credits spreads tight in the near-term. Accordingly, we anticipate that a 2.2% rally in high yield bonds is more likely than a 6.5% correction in the S&P 500.
Continue to monitor the relative strength of HYG to SPY for signals of a local market top. We hope to see near-term HYG outperformance. Be aware, weakness in equities is often preceded by a loss of momentum in credit markets. If high yield bond prices do not stabilize, the probability of a meaningful correction in equities increases.
disclosure: The opinions expressed in this Weekly Chart Book report are those of the author. The materials and commentary are strictly informational and should be used for research use only. This bulletin is not intended to provide investing or other advice or guidance with respect to the matters addressed in the bulletin. All relevant facts, including individual circumstances, need to be considered by the reader to arrive at investment conclusions that comply with matters addressed in this bulletin. Charts and information used in this report are sourced from Bloomberg.