With the increased volatility this year after such a long period without any significant declines has got some wondering if the market has peaked, or even about to crash. To get a better idea of what’s going on ‘under the hood’, we can study the high yield ‘junk credit’ market. High yield is also known as ‘junk credit’ for its higher risk of default and being rated below investment grade. This heightened risk means greater sensitivity to market conditions, and can serve as a 'canary in the coal mine'.
The Merrill Lynch High Yield index has a yield of 6.36% at the moment. This is close to the 6% combined ‘yield’ of the S&P500 trailing earnings and dividend. When junk bond market is under stress and fear of default is rising, the yields ‘blow out’ or spike quickly. (We’re seeing this happen right now with concerns over TSLA credit).
The chart shows how yields 'blew out' during times of stress. The orange line is the additional yield offered by the high yield index after subtracting the ‘risk free’ treasury rate. This ‘spread’ gives us a better idea of the risk premium demanded by junk credit investors. Currently the spread remains lower in around the range under 3.6%.
The S&P500 index in blue is compared to the Merrill Lynch B grade corporate yield spread. At each of the previous peaks before the stock market crashed, there was a sudden spike in the credit spread. We even saw this spike in 2011 and 2015 when default fears increased. At the moment we’ve yet to see a similar jump in the high yield spread. Which would suggest that currently investors are not sensing any increasing risk of default (at least for now). A spread approaching the long term median or average range of 5% would give cause for alarm.
The Merrill Lynch high yield spread chart is updated daily here:
https://fred.stlouisfed.org/series/BAMLH0A0HYM2
The WSJ updates bond benchmarks daily here:
http://www.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html
The Merrill Lynch High Yield index has a yield of 6.36% at the moment. This is close to the 6% combined ‘yield’ of the S&P500 trailing earnings and dividend. When junk bond market is under stress and fear of default is rising, the yields ‘blow out’ or spike quickly. (We’re seeing this happen right now with concerns over TSLA credit).
The chart shows how yields 'blew out' during times of stress. The orange line is the additional yield offered by the high yield index after subtracting the ‘risk free’ treasury rate. This ‘spread’ gives us a better idea of the risk premium demanded by junk credit investors. Currently the spread remains lower in around the range under 3.6%.
The S&P500 index in blue is compared to the Merrill Lynch B grade corporate yield spread. At each of the previous peaks before the stock market crashed, there was a sudden spike in the credit spread. We even saw this spike in 2011 and 2015 when default fears increased. At the moment we’ve yet to see a similar jump in the high yield spread. Which would suggest that currently investors are not sensing any increasing risk of default (at least for now). A spread approaching the long term median or average range of 5% would give cause for alarm.
The Merrill Lynch high yield spread chart is updated daily here:
https://fred.stlouisfed.org/series/BAMLH0A0HYM2
The WSJ updates bond benchmarks daily here:
http://www.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html