The reason the market doesn't go down is staring at us

CREDIT SPREADS.

The lifeblood of finance /s

Well to be honest, it's the only reason I can think of that 5% rates aren't dragging things lower.

Take a look at the below chart...

Which textbook would tell you that credit spreads, especially in the high yield sector, would be lower at 5% interest rates than when they were at 1.5%?!

It's insanity, right?

Credit spreads pretty much show us the stresses in the market, more than just equities.

Above is the high yield (HY) option adjusted spread...

So everything is going just beautifully in the HY market, guvna?

Hmmm... maybe not.

If we consider the current 12 month trailing PE of the Russell – which likely holds most of the higher yield dogcrap in it – has been cut in over HALF since last year, from 63.23 to 26.96.

Comparatively, the SP500's 12 month trialing PE has gone from 21.95 to 20.37, and the NASDAQ's has even INCREASED, going from 25.75 to 32.72.

So there are big discrepancies the further down the 'value' chain we move, with smaller cap equities likely feeling the pressure.

What's likely keeping a lid on things here?

Probably fundamentals – we still haven't seen a big deterioration in employment for example, which tends to create the situation where credit contracts.

Below you can see commercial and industrial loans vs the Effective Fed Funds rate.

Through 2023, we have seen the first contraction since we were in the midst of the pandemic...

And this is with quantitative tightening going on too!

More interesting is the dispersion of bond yield spreads...

We can see there is a BIG old uptick in >700bp HY bond spreads now, while most congregate around the 200-300 range.

What would be alarming is if the gradual shift happens to the right...

200-300 becomes 300-400 and so on.

And the market doesn't look strong on an issuance basis either...

Dollar denominated AND euro denominated corporate debt are being issued at the lowest amount so far over the past four years.

So what are we really waiting for?

I think again, we head back to what I wrote about a while back...

It all comes back to employment.

Fact.

If more people aren't employed, there is less profit being made and less credit flies around the economy, making credit markets more ILLiquid.

That's all we're waiting for in my view, and with this comes the ability to look at US bonds in the same way as gilts...

But not just yet, I'll take a pause for a sec there...