The amount of extra yield that investors demand for risky corporate bonds has fallen, in a sign beyond the stock-market rally that fears that a U.S. recession may be looming may have abated.
“High yield spreads, as measured by the BofA High Yield Master Index, dropped to their lowest levels since April 2022 last week, ending what was more than a year-long drought without a 52-week low,” said Bespoke Investment Group, in a note emailed Tuesday. “As markets have rallied and the gains have broadened out, the number of indicators confirming the equity market’s rally has also started to expand,” with high-yield debt being the latest example.
In the U.S. junk bond market, high-yield spreads over comparable Treasurys tightened to 390 basis points on July 14, the Bespoke chart below shows.
“High-yield spreads typically move in the opposite direction of stock prices, so when spreads hit 52-week lows, stocks are typically at or near 52-week highs,” said Bespoke.
Credit spreads in the high-yield bond market tend to increase when investors become anxious about possible economic trouble ahead.
The “implosion” of Silicon Valley Bank and First Republic Bank in March “sparked worries of a broader tightening of credit in riskier parts of the market but based on recent moves in the high-yield market, that sector has been relatively unscathed,” said Bespoke.
Investors worried that a potential pullback in lending due to the regional-bank failures would lead to an economic downturn that many already feared was looming because of the Federal Reserve’s aggressive monetary tightening aimed at taming elevated inflation.
Read: ‘I don’t expect a recession’: Yellen says U.S. economy on ‘good path’
Meanwhile, bank stocks were jumping Tuesday after major Wall Street firms including Morgan Stanley reported their quarterly earnings, helping to fuel broad stock-market gains.
The U.S. stock market has been climbing in 2023, with the S&P 500 continuing to rise after booking its strongest first half of a year since 2019. The index has soared more than 18% year to date, based on Tuesday afternoon trading, after on Monday closing at a 52-week high.
The S&P 500
SPX,
ended Monday at 4,522.79, its highest closing value since April 5, 2022, according to Dow Jones Market Data.
Junk bond ETFs have also posted gains this year. For example, the SPDR Bloomberg High Yield Bond ETF
JNK,
has seen a total return of 6.2% so far this year, FactSet data show.
“Friday’s decline in high-yield spreads was notable since it ended a streak of more than a year (386 trading days) where high-yield spreads went without hitting a 52-week low,” said Bespoke.
With high-yield spreads below 400 basis points, “they are near the low end of their historical range,” the firm said. “Whenever spreads near historically low levels, it raises concerns that sentiment is getting too complacent as investors require much less normal compensation to account for the riskier credit quality of issuers.”
But the firm found that history since 1998 shows the S&P 500 may wind up higher a year after high-yield spreads hit a 52-week low “after at least 200 trading days without doing so.”
“While shorter-term performance may have been on the weak side, longer-term performance was better,” said Bespoke. “One year later,” said Bespoke, the S&P 500 had “an average return of 9.3% versus a long-term average of 6.9%.
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