Learn more about Bespoke’s research and wealth management services.

Whenever we are looking for positive or negative divergences in the equity market, one area we look to is the high yield credit market.  Here, we look to see how spreads on high yield debt relative to treasuries are trending over time.  If you are unfamiliar with the term, when we use the term spreads we are simply referring to the difference in yield between a high yield debt security and the yield of a US treasury with a similar maturity.  Generally speaking, rising spreads in the high yield market indicate an increase in risk aversion on the part of investors as the higher spread indicates that investors are requiring higher compensation in exchange for taking on the credit risk.  Conversely, when spreads are narrowing it indicates that investors are willing to take less in the way of compensation for the particular credit risk.

In the chart below, we have plotted the S&P 500 (blue line) versus high yield spreads (red line) based on the Merrill Lynch High Yield Master II Index.  However, since spreads tend to move in the opposite direction as prices, we have plotted them on an inverse basis in order to make it easier to compare the two.  Looking at the chart, high yield spreads and the equity market have generally tracked each other pretty closely over time.  The only period of divergence was a positive one in the summer, where the S&P 500 was drifting lower while spreads continued to narrow.  Ultimately, that divergence was a good reason to stay positive even during the uncertainty regarding the election.

Fast-forwarding to the present, high yield spreads have been tracking the S&P 500 pretty closely over the last several weeks.  In fact, the S&P 500 saw its most recent peak just as spreads in the high yield market reached their narrowest levels, and since their respective extremes, the S&P 500 has been drifting lower as spreads have been listlessly moving higher.  If you’re a bull, in an ideal world you would prefer to see spreads remaining near their narrowest levels or making new lows during this period of consolidation for the S&P 500, but at this point judging by the movement in the high yield market, there is nothing to suggest that the last six weeks of trading have been anything more than a pause.

High Yield Spreads vs S&P 500

Print Friendly, PDF & Email