Credit Spread Tightening Gives the “All Clear” for Equities

April 18, 2016

Credit Spread Tightening Gives the “All Clear” for Equities Photo

For the last few weeks, equity markets have traded in a fairly tight range. For example, the S&P 500 Index has traded in a less than 2.5% range for the last month. During this time, economic data has become very much in-line with consensus thinking that the U.S. economy continues along with moderate growth and decent job gains. Inflation data last week for both the Producer Price Index (PPI) and Consumer Price Index (CPI) were slightly below expectations and still haven’t shown the uptick I am expecting to see in the coming months.

For the better part of the last year, I observed credit spreads acting as a good leading indicator of equity and risk market price moves. If this correlation holds true, then the recent strong performance of investment-grade and high yield credit bonds could indicate more upside for equities is ahead. I don't expect to see a large move higher, but in the absence of some new information on the economic front, or weaker-than-expected earnings, the credit markets could continue to fall and give the all clear for further equity market gains.

Keep watch on two items for longer-term markets. The strong move in the Japanese Yen is troubling and a sign of a potentially significant shift in investor sentiment. Also, keep an eye on how central banks react to the growing warnings surrounding the implications for negative interest rates. I am concerned about negative rates, but in the absence of solid fiscal policy across the globe (especially the U.S.), central banks are left to use a tool that proves to be less and less effective at stimulating growth.

Tags: Monday Morning O'Malley | Inflation | Yen | Credit spreads | Equity market | Negative rates

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