Corporate Bond Spreads
I follow this indicator closely, perhaps because of my many years as an institutional fixed income portfolio manager. Corporate bond investors are highly sensitive to weakening economic conditions. This is especially true of junk bond investors. Unlike equity investors who participate directly in the growth of earnings and dividends, the upside for corporate bond investors is limited. Either you receive your coupon and principal payments or you don't. Sure, spreads could narrow, but the probability of receiving your future payments is of paramount importance.
Therefore, junk bond investors are highly focused on quantifying and forecasting downside risk, while equity analysts can be temporarily blinded by the unlimited upside potential of their favorite stocks. As a result, perceived increases in default risk show up in widening junk bond spreads, often before they emerge in equity prices.
Market-based leading indicators typically respond more rapidly than leading economic indicators; junk bond spreads are no exception. The recent increase in junk bond spreads is troubling for the equity markets, especially given the dramatic recent increase in equity market volatility.
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