Low Yield Spreads Suggest Recession Fears May Be Easing

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The demand for risky corporate bonds has shown signs of improvement, indicating that fears of a U.S. recession may be subsiding. According to the BofA High Yield Master Index, high yield spreads have fallen to their lowest levels since April 2022. This drop in spreads, combined with the broadening gains in the market, suggests a positive outlook for the equity market.

In the U.S. junk bond market, high-yield spreads over comparable Treasurys tightened to 390 basis points on July 14. Historically, when high-yield spreads hit their lowest levels, it is often an indication that stock prices will reach or near their 52-week highs.

Typically, credit spreads in the high-yield bond market increase during periods of economic uncertainty. However, recent movements in the market indicate that it has remained relatively unaffected despite concerns sparked by the failures of Silicon Valley Bank and First Republic Bank in March.

Investors were worried that these failures could trigger a wider credit tightening in riskier areas of the market and potentially lead to an economic downturn. However, recent developments suggest that this sector has weathered the storm, providing some relief to investors who were already concerned about the Federal Reserve’s aggressive monetary policies aimed at curbing inflation.

Overall, the decrease in high-yield spreads is a positive sign for the economy, indicating that a recession may not be imminent.

Stock Market Continues to Soar in 2023

Major Wall Street firms, including Morgan Stanley, reported their quarterly earnings, leading to a surge in bank stocks on Tuesday. This positive news has contributed to the ongoing growth in the U.S. stock market. The S&P 500 has experienced a remarkable first half of the year, with a year-to-date increase of over 18%. In fact, it closed at a 52-week high on Monday, reaching its highest value since April 5, 2022.

Impressive Performance of the S&P 500

According to Dow Jones Market Data, the S&P 500 ended Monday at 4,522.79. This remarkable closing value demonstrates the strength and resilience of the market.

Junk Bond ETFs Show Promising Returns

Not only have stock markets thrived, but junk bond ETFs have also seen notable gains this year. For instance, the SPDR Bloomberg High Yield Bond ETF has achieved a total return rate of 6.2% thus far in 2023, based on FactSet data.

High-Yield Spreads Highlight Investor Sentiment

Bespoke, a reputable firm, observed a significant decline in high-yield spreads on Friday. This decline broke a streak of more than a year (386 trading days) during which high-yield spreads failed to reach a 52-week low. With spreads now below 400 basis points, investors express concern that sentiment may be too complacent, as they require less compensation for taking on riskier credit quality issuers.

Historical Momentum and Future Expectations

Despite these concerns, Bespoke’s analysis since 1998 has shown that the S&P 500 tends to perform well following a 52-week low in high-yield spreads after at least 200 trading days without such an occurrence. While the shorter-term performance may be weak, the longer-term performance tends to improve significantly. In fact, on average, one year after these lows, the S&P 500 has yielded a return of 9.3% compared to the long-term average of 6.9%.

The stock market’s continuous upward trend in 2023 indicates a positive outlook for investors, with promising returns and potential future growth.

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