Stocks have enjoyed an impressive bounce from their bear market lows, caused by the Coronavirus and recession. While it has become clear that earnings are heading lower and that stocks will have to reflect this, there’s a less talked about statistic that usually precedes more selling.
An improving credit market not is not an immediate sure-fire indicator of equity market strength, and in the last economic meltdown, it preceded more near-term selling.
The S&P 500 fell 34% from its all-time-high hit in February, then bounced 25% and out of bear market territory. Now, as the coronavirus spread decelerates globally and the Federal Reserve pumps trillions of dollars of liquidity into all sectors of the bond market, from member bank repo operations to the high yield market, many on Wall Street are calling for a near-term and meaningful pullback before we finally get that sustained bull market again. The U.S. isn’t out of the woods on the virus. There is limited visibility on the sharpness of a recovery. The flow of new liquidity to all members of the economy remains a question mark in terms of speed and use of funds.
Meanwhile, company analysts have revised earnings estimates for 2020 down by 12%, compared to the S&P 500’s year-to-date loss of 14%. But strategists note that the earnings revisions could be as severe as negative 40%, as analysts have essentially updated models on a lag to reality. And that doesn’t even address distressed debt levels in some businesses and lowered earnings forecasts for 2021 and 2022.
One factor that has given stock investors solace is that, along with the Fed’s support of the carpet on market (investment grade and high yield), the iBoxx iShares High Yield Corporate Bond ETF (HYG) from BlackRock has seen its share price rise 17% since March 23, the current 2020 low point in risk asset markets. In that time, the aggregate U.S. high yield credit spread has fallen from above 1,000 basis points (10%) to around 800 basis points. That means investors are willing to accept 8% more than the risk-free 10-year treasury bond, rather than the 10% demanded at the market’s recent bottom.
Importantly, after the S&P 500’s 5% gain last week, the market is losing steam Monday. The HYG share price was down 1.74% Monday, which was mostly risk-off.
This all sets up Canaccord Genuity’s Chief Market Strategist Tony Dwyer’s point: the solid price action of the noted high yield one ETF absolutely does not reflect positive forward sentiment in stocks.
Dwyer noted that, in light of Thursday’s 6.6% share price gain on the bond ETF, “The other two times the HYG saw greater than Friday’s 6.6% ramp [market was closed Friday] did not represent “the” low in the market.”
In late 2008, the HYG had an up day of more than 7%.The S&P 500 fell 37% from that level to its bear market low, before the bull run of the past 11 years began. Later in 2008, the HYG had a 12% up day, which preceded 30% of lost value on the benchmark index before the bull run. That’s according to Dwyer’s long-term graph of the S&P 500.
The point, which some on Wall Street are making Monday: be careful with stock in the near-term. The market may have to rip the band-aid off before the wound begins to heal for good.
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