The story goes into the strange world of the "spread" of corporate bonds to U.S. Treasuries and what it could mean for the broader economy. A wider spread of "corporates" to "Treasuries" can mean that investors want more yield to hold the debt of U.S. companies. While other factors can be in play, this is important because it can mean that investors have less confidence about these companies' business prospects, hence the warning. And when investors are less confident about a company's business, its stock is also affected.
"The issue behind this bear phase in stocks isn't earnings; it's worries about credit -- specifically in the high-yield bond market," TheStreet's Jim Cramer wrote on RealMoney.
The market wants as little risk as possible, Cramer noted.
High-yield, or lower-grade bonds, can be considered toxic in this risk-off environment. When investors are looking to take risk off of their fixed-income portfolio, they begin to worry about the spread between Treasuries, or "risk-free" bonds, and corporate bonds, which tend to be riskier investments.
In the search for yield in a zero-rate environment, investors have moved out the curve and down in quality, toward high-yield and away from Treasuries. But now the pendulum could be swinging the other way.
There is an indicator of what investors think about corporate debt that dates back to the early 1930s: the Barron's Confidence Index (BCI). Barron's says that the BCI is calculated by the high-grade index divided by the intermediate-grade index. "The decline in the latter vs. the former generally indicates rising confidence, pointing to higher stocks," says the weekly. Therefore, the opposite is also true -- meaning a decline in the high-grade vs. the low-grade generally indicates waning confidence, which is exactly what we're seeing now.
In the Sept. 28 issue of Barron's, the BCI dropped sharply to 73 from 75.4. Most of this movement came from the sharp drop in the yield of the "Best Grade Bonds" to 3.67% from 3.82%. "The Intermediate-Grade Bonds" yield only declined 3 bps to 6.03%.
Since yield and price have an inverse relationship, the falling yield in the "Best Grade Bonds" implies rising prices and a flight to quality as demand increases for the higher-quality bonds and more investors abandon their lower-grade peers. Maybe investors really are running scared to the security of only the best bonds. Is the long ignored BCI is due for a revival?