High/Low vs Rising/Falling Credit Spreads and the Stock Market
By Michael Stokes | September 03, 2008 | 1:10 PM | 1 Comment
In my recent post Rising Credit Spreads and the Stock Market I demonstrated that widening credit spreads (AKA increasing difference between corporate and treasury yields) has generally been bullish for the stock market over the last 50+ years.
In this post I want to look at how the market reacts when credit spreads are high or low compared to historical norms (note the difference: the first post was about direction, this post is about magnitude).
All of this analysis was brought on by the fact that now, at this very moment, credit spreads are both in a strong up trend and approaching historical highs. The graph below shows monthly average credit spreads between BAA rated corporate bonds and 10-year Treasuries over the last 50+ years.
All interest rate data from St. Louis FRED Database
In the following graph I divided average monthly credit spreads over the last 50+ years into four quartiles (based on how high or low they were) to look at how the S&P 500 performed in the month following the lowest 25% (red), 25-50% (orange), 50-75% (blue), and top 25% (green).
All data is in monthly intervals. Chart is logarithmically scaled.
Quite frankly I can't draw a strong conclusion from the chart. I hate to post about things that don't work, and usually I don't, but in this case I wanted to alleviate fears that the high credit spreads we're seeing now are necessarily going to have a significant impact on equities.
For now I'm concluding that: although we've shown previously that widening credit spreads (AKA direction) have been more bullish for the stock markets, whether credit spreads are relatively high or low (AKA magnitude) does not appear to have a consistent positive or negative impact on the stock market.
Happy Trading,
ms
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