Better Than It Looks

After a stellar 2024 and strong January 2025, February has been a bit of a cold shower moment for investors. Bad new seem to come every day, and markets have been quite jittery.

 

As I mentioned last week, we are still in a long-term bull market, and what we experiencing now appears to be nothing more than a short-term correction. It is quite normal to have 5-10% drawdowns even during strong years. Someone reminded me earlier this week that we had an 11% pullback back in 2023 (lasting from August to October). Many people forgot about that because 2023 produced strong double-digit returns.

 

The current pullback is in line with historical norms. That being said, we are not just sitting on sidelines. Since early February (before the selloffs), My team and I have been running fire drills in case "this time it will be different.”

 

I looked at all bear markets over the last 25 years, and one thing stood out: the consistency with which high-yield bond spread expansion signalled all previous bear markets.

 

The chart below will provide visual details of what I am referring to.

 

The black line in the top panel represents the S&P500, going back to late ‘90s. The pink line below represents high-yield bond spreads. As a quick reminder, these spreads represent the premium that high-yield bond investors receive over and above government bond investors for taking extra risk. When market conditions deteriorate, spreads go up. I have highlighted all major selloffs and bear markets with vertical green lines. Notice that all major selloffs were accompanied by spread expansion.

 

I am not seeing that now (at least for the time being). In fact, spreads have been steadily declining over the last few years. If bond investors are not worried, stock investors should take a step back and stay calm.