Authored by Simon White, Bloomberg macro strategist,
Speculation continues to drive shares greater and volatility decrease, thus retaining credit score spreads contained. But over-extended breadth in equities might be one indication for when spreads will widen.
Credit spreads proceed to tighten, defying indicators of deteriorating fundamentals. Bank credit score is tightening, bond and leveraged-loan defaults are rising, charge-off and delinquency charges for loans are climbing, whereas company chapter filings have risen sharply. Even the US will not be free from the worsening international credit score outlook, in the event you agree with Fitch’s evaluation behind its downgrade of the nation’s sovereign debt.
The inventory market continues to grind greater, in such a means that index volatility throughout maturities is falling, together with within the one-day VIX, which has simply hit a collection low. One driver is the narrowness of shares driving the advance, pushing implied correlation decrease.
The different is choice hypothesis, pushed in good half by traders promoting calls. This will increase gamma, and causes sellers to repress volatility as they hedge their positions.
High-yield credit score spreads and fairness volatility have a tendency to maneuver carefully collectively for good elementary causes, with the outcome that the VIX and HY credit score spreads have each declined this yr.
A pop in fairness volatility would subsequently doubtless coincide with a widening in credit score spreads – and that may very well be abrupt given the worsening backdrop in credit score markets.
Seasonally, August and September are the 2 months of the yr that see the highest common rise within the VIX, so it is going to pay to remain alert via the so-called foolish season.
And it is going to additionally pay to keep watch over breadth within the fairness markers for indicators of market over-extension or capitulation. Very few breadth indicators are flashing hazard in the mean time, however they’re transferring in that route. The share of S&P shares above their 200-day transferring common is over 70%, decrease than earlier market peaks, but it surely has risen rapidly.
The advance-decline for the S&P line can also be stretched, however not but fairly at alarm-bell ranges (see chart beneath). Similarly the variety of shares on the NYSE making new 52-week highs stays at reasonable ranges, however rising.
Breadth might be one sign to look at (amongst others) highlighting when shares, vol and credit score are liable to take a flip for the more severe.