The Rising Influence of Rising Affluence

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Here’s the incredibly strong signal for stocks that is coming from the corporate bond market

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https://www.marketwatch.com/story/heres-the-incredibly-strong-signal-for-stocks-that-is-coming-from-the-corporate-bond-market-11658401317

By Steve Goldstein
Critical information for the U.S. trading day

Is it a false dawn in the stock market or is there something real? The S&P 500 has never lost ground over the following year when advancing volume was at least 85% of volume for two out of three days coming off a 52-week low, according to Jason Goepfert, the founder of Sundial Capital Research. That has happened 13 times.

Here’s another: The S&P 500 (SPX) closed higher on Wednesday for the first time since March after a day in which it gained at least 2%. You can now buy the dip without automatically and instantly getting punished.

But our call of the day studies the link between the corporate bond and stock markets. Spreads in both investment grade and riskier high-yield bonds have narrowed rapidly over the last three weeks.

Analysts at Bespoke Investment Group studied the history of such spread compression, though it isn’t a long series since the popular credit-default swap indexes were only invented this century.

The signal is incredibly strong on the junk-bond side. In the nine previous times when the CDX HY spreads fell at least 75 basis points in three weeks, the S&P 500 rose over the next week, six months, and year, with 22% average returns over the next year. “It’s awfully hard to come up with a market signal that looks much better than that long-term,” said the Bespoke analysts.

On investment-grade bonds, it is less strong but still positive. When the CDX IG spread has fallen at least 15 basis points over three weeks, and that has happened 14 times since 2005, the S&P 500 rose in a year’s time in 12 of those occasions, with an average gain of 13%.

A word of warning, however. At current pricing, junk bonds (JNK) aren’t pricing in a recession, according to BCA Research. The index is pricing in a default rate of 6.65%. “Given that default rates typically surpass 8% during recessions, there is scope for spreads to widen further if recessionary risks intensify,” said the BCA analysts.