Wednesday, January 12, 2011

Credit spread update: room for more improvement

The top chart shows credit default swap spreads for short-term corporate debt, while the bottom chart shows option-adjusted spreads for the whole corporate debt market. Both show that spreads have declined significantly since the worst days of the 2008-9 recession, but they also show that spreads are still substantially higher than they have been during times of relative economic tranquility.

I've argued repeatedly that the current level of credit spreads is a good indicator that the U.S. financial market is not overly exuberant, over-priced, or in another bubble. The market is still priced quite conservatively, and this is not surprising since there are still many problems facing the U.S. economy that must still be resolved (e.g., the huge unfunded liabilities of social security and medicare; the very large federal deficit; the unprecedented expansion of the size of the federal government; the still-large inventories of foreclosed homes, and the millions of homeowners who are "underwater" on the mortgages). We are moving in the right direction, but there is still plenty of room for improvement.

By inference, corporate debt still offers attractive spreads over Treasuries, especially in the high-yield sector.

Full disclosure: I am long HYG at the time of this writing.


brodero said...

I believe corporate bond yields are one of the best indicators of stress and valuation for the stock market and yet few in the internet
blogs follow them. As long as spreads remain reasonable and more
inportantly yields subdued ( I look at Baa Yield at 7% as a warning sign,,it is around 6.10 now)
we will have an upward bias to stocks....

Benjamin Cole said...

Nice rally on Dow again. You can see 12k from here.

I know it is just a feeling, but when the market passes through 12k, I think you will see a burst of optimism.

John said...

Again, the top performing sector YTD is the financials. I am not certain that they will be the top performing sector for the year but I predict they will outperform the S&P 500 for 2011.

The Fed is in the process of restoring prosperity to not only the US economy, but the whole world's.

Thanks to Scott Grannis for consistently presenting the evidence of an economic recovery transforming into an economic expansion, not just in this country but also the world.

Jay Norman Davis said...

I know you are partial to hyg which I also own, is there anything in the portfolio of jnk that makes you favor hyg.

As always

Thank you,

Jay Davis

Scott Grannis said...

I don't think there's a significant difference between the two. I note that total returns over the past 3 years have been very similar.