Credit Markets

One of the best indicators this year in raising the red flag before a pullback has been the junk bond (AKA: high yield) market. Shown below is the Barclays U.S. Corporate High Yield Average Option Adjusted Spread (OAS) inverted for directional similarity along with the S&P 500. The OAS spread began to tick higher before the June/July and the Sept/Oct pullbacks as seen by the yellow highlighted boxes. Currently we are seeing the OAS spread tick higher again, warning that the markets latest advance into new high territory is upon shaky ground.

High Yield OAS
Source: Bloomberg

Other signals echoing caution are credit default swaps (CDS) on investment grade (blue line below) and high yield (red line) corporate bonds shown below in the bottom panel, inverted. You can see that whenever there is a divergence with corporate bond CDS and the S&P 500 over the last year the S&P 500 tends to play catch up within a few days or weeks. Like the OAS spread, the CDS on corporate bonds is heading higher (lower in chart) and suggests we could see a bout of profit taking in the stock market.

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