High Yield Spreads are Contracting

Igor Manukhov - Jan 15, 2024

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High Yield bond spreads have been contracting. This is what you want to see in a bull market.

As I mentioned before, I expect the market to continue to rise by the end of the year. What will happen between now and then, is anyone’s guess. The market will have it’s shorter term peaks and valleys, but the overall trend is expected to be up. I use multiple tools and indicators in my work and I want to share with you one of them today. This particular indicator is referred to as an inter market indicator. It shows how different markets interact with one another throughout the cycle.

Today I will show you the relationship between High Yield bonds and the stock market. High yield bonds are an interesting asset class. In my opinion, from a risk standpoint, high yield bonds have more in common with stocks as opposed to high quality bonds. They tend to outperform traditional (investment grade) bonds during good times (just like stocks), and they tend to get hit pretty hard and underperform high quality bonds during stock market corrections.

One interesting indicator to watch is the high yield bond spread (the black line on the top panel). This indicator shows how much extra yield (in %) and investor can get by investing into high yield bonds versus investment grade bonds. When times are good, this spread will decline as investors are more comfortable taking on extra risks in exchange for extra returns. When times are bad, high yield bonds due to their low quality nature tend to decline in price substantially, often leading this spread higher.

The chart below depicts this spread (black line) beside the stock market price chart (red line). The blue lines on both charts represent 30 week moving averages, which depict a smoother trend. Notice I have drawn purple circles around times when spreads have been contracting. You can see this tends to correspond with pretty strong stock market performance.

This is another confirmation that a bull market is here. When this spread starts to expand, this will be a warning sign that the stock market could be in for trouble. For now, I would follow the trend and enjoy the returns until the picture changes.

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High Yield Spreads are Contracting

Igor Manukhov - Jan 15, 2024

High Yield bond spreads have been contracting. This is what you want to see in a bull market.

Igor Manukhov

Peter Kuntyj

Yelena Manukhova

Brittany Stone

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