High yield spreads and equity volatility

 

The focus for most investors has been on equity markets. Equities have had a nice run especially with the decline in recession expectations. Rates have been confusing for investors. The expectations were for a strong decline as the Fed changed gears towards a looser policy. The market is adjusting to a more cautious Fed. The critical issue is with credit given the strong demand for credit funds especially in the alternative investment space. 

There are clear indicators that can be used to help with assessing the credit arena. Economic growth is one for the macro environment. Earnings is a key indicator for micro credit investing. However, a clean simple indicator is the VIX index. If equity volatility, a proxy for uncertainty, is on the rise, there will be an increase in credit risk. In general, if the VIX is below 20, they're low likelihood of a spread increase. If the VIX index is above 20 and rising, there is greater credit risk regardless of what rates may be doing. Of course, facing rates make it easier to refinance, but the compensation for holding corporate risk can still higher. There is little current credit spread risk.