One important indicator is nearing code red
One of the best coincident and real-time indicators of bursting bubbles and recessions is the yield spread between US high-yield corporate bonds and the 10-year US Treasury. It isn't flashing code red just yet, but it has gone from green to orange over the past year. The yield on the Merrill Lynch junk bond composite is up 205bps from last year's low of 5.16% on June 24 to 7.21% currently. The yield spread has widened from 257bps to 501bps over this same period.
Apparently, stock traders didn't get the all-points bulletin from the credit department. In the past, the S&P 500 VIX measure of volatility has been highly correlated with the yield spread between corporate junk and Treasuries. However, so far, it remains near this year's lows despite the widening of the spread. That's complacency for sure, which may or may not be warranted. It may be that stock investors figure that most of the problems in the junk bond market are in the energy segment, which accounts for about 17% of the market. That's big, but not big enough to cause a contagion in the credit markets. Complacency can also be found in the Nasdaq 100 VIX, which has been relatively calm since early 2012.
There is less complacency in Investors Intelligence's Bull/Bear Ratio, which plunged from 3.14 to 2.05 over the past four weeks. However, that was mostly because of a big drop in the percentage of bulls who stampeded into the correction camp rather than turning into outright bears. The percentage in the correction camp jumped to 43.9% this week, the third highest reading on record, with the all-time high set during the week of October 21, 2014 at 46.5%.
Today's Morning Briefing: When Bubbles Burst. (1) Commodity super-cycle latest bubble to burst. (2) Must a recession follow? (3) Junk getting junkier. (4) All-points bulletin from the credit department. (5) Complacent VIX. (6) Near-record high in stock correction camp. (7) Emerging markets have an urge to submerge. (8) That sinking feeling in the commodity pits. (9) What to expect when expected inflation is so low. (10) Gundlach and Kocherlakota voting for "none-and-done." (11) Housing has solid foundation. (12) Will Millennials be single renters forever? (13) Focus on underweight-rated S&P 500 Materials. (More for subscribers.)