The Ingredients of a Market Crash
John Hussman reports:
The most hostile subset of market conditions we identify couples overvalued, overbought, overbullish extremes with a breakdown in market action: deterioration of breadth, leadership and other market internals, along with a shift toward greater dispersion and weakening price cointegration across individual stocks, sectors and security types (what we sometimes call “trend uniformity”).
The outcomes are particularly negative, on average, when that shift is joined by a widening of credit spreads.
That’s a shift we observed in October 2000. It’s a shift we observed in July 2007. It’s a shift that we observe today.
Credit Suisse strategist Andrew Garthwaite: a widening in US high yield spreads of c.115bp has preceded an equity market correction (i.e. a fall of more than 10%), and typically this degree of sell-off in high yield has led an equity market correction by around 3 months. In the current episode, high yield spreads troughed on June 23rd (i.e. 3 months ago) and have now risen 108bp from their low.
The Nattering One muses... A credit spread is the difference in yield between two bonds of similar maturity but different credit quality.
For example, if the 10-year Treasury note is trading at a yield of 6% and a 10-year corporate bond is trading at a yield of 8%, the corporate bond is said to offer a 200 bps (basis point spread) over the Treasury.
Widening credit spreads indicate growing concern about the ability of corporate (and other private) borrowers to service their debt and are indicative of an economic contraction or recession.
Narrowing credit spreads indicate improving private creditworthiness. As credit spreads have been compressing since mid 2011, investors have been stretching further into lower rated fixed income securities to reach for yield.
With the current widening and the Fed exiting QE3 on Oct 29th, we think interest rates will rise and this will offset the yield that investment grade corporate bonds have offered.
Any rise in rates, mandated by the Fed or market forces, could trigger a violent unwind of the carry trades on which today's asset bubbles are built.
The most hostile subset of market conditions we identify couples overvalued, overbought, overbullish extremes with a breakdown in market action: deterioration of breadth, leadership and other market internals, along with a shift toward greater dispersion and weakening price cointegration across individual stocks, sectors and security types (what we sometimes call “trend uniformity”).
The outcomes are particularly negative, on average, when that shift is joined by a widening of credit spreads.
That’s a shift we observed in October 2000. It’s a shift we observed in July 2007. It’s a shift that we observe today.
Credit Suisse strategist Andrew Garthwaite: a widening in US high yield spreads of c.115bp has preceded an equity market correction (i.e. a fall of more than 10%), and typically this degree of sell-off in high yield has led an equity market correction by around 3 months. In the current episode, high yield spreads troughed on June 23rd (i.e. 3 months ago) and have now risen 108bp from their low.
The Nattering One muses... A credit spread is the difference in yield between two bonds of similar maturity but different credit quality.
For example, if the 10-year Treasury note is trading at a yield of 6% and a 10-year corporate bond is trading at a yield of 8%, the corporate bond is said to offer a 200 bps (basis point spread) over the Treasury.
Widening credit spreads indicate growing concern about the ability of corporate (and other private) borrowers to service their debt and are indicative of an economic contraction or recession.
Narrowing credit spreads indicate improving private creditworthiness. As credit spreads have been compressing since mid 2011, investors have been stretching further into lower rated fixed income securities to reach for yield.
With the current widening and the Fed exiting QE3 on Oct 29th, we think interest rates will rise and this will offset the yield that investment grade corporate bonds have offered.
Any rise in rates, mandated by the Fed or market forces, could trigger a violent unwind of the carry trades on which today's asset bubbles are built.
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