- Main US indices off lows, slightly red; token gains
- Disk versus weaker S&P major sector; energy drives winners
- The Euro STOXX 600 index ends at ~0.3%
- Dollar ~ flat, gold, bitcoin gain, crude down
- The 10-year US Treasury yield rises to ~1.97%
CORP CREDIT SPREADS FLASH WARNING SIGNS FOR RISK ASSETS (1212 EST/1712 GMT)
The rising cost for companies to issue debt is a warning signal for risky assets and may indicate lower equity returns going forward.
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Companies have benefited from cheap debt to fund operations or finance share buybacks and acquisitions as loose monetary policy keeps interest rates down and investors seek higher-risk assets to generate returns . But those costs are now rising as treasury bond yields rise and lenders demand a higher premium than treasury bills for credit exposure.
“Credit spread measurement is our canary in a coal mine,” Jack Ablin, chief investment officer at Cresset Wealth Advisors, said in a report sent Tuesday, and “the canary died last week.”
Ablin looks at spreads for 10-year corporate bonds rated BBB, which is the lowest level of investment grade. That spread has now moved more than 10% above its 200-day moving average, meaning “the signal is now risk-free, something we haven’t seen since the peak of the pandemic in 2020”.
Historically, the S&P 500 has returned 3.5% over the next six months, on average, after a credit break, compared to a return of 6.4% after a positive credit break, Ablin said, adding that “the technological disaster of 2001 and the financial crisis of 2008 were preceded by credit shortages.
Meanwhile, rising high-yield bond yields could begin to eat away at companies’ operating margins, which are at record highs, according to Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.
“Historically, higher interest rates are inversely correlated with profit margins, as the rising cost of capital eats away at profits. This time, rising costs of labor, energy, distribution and commodities may be the first to squeeze margins, but borrowing costs are worth watching,” Shalett said in a note sent Tuesday.
Yields on high-yield bonds rose to 5.58% from 4.35% at the end of 2021 and a low of 3.92% last July, according to the ICE BofA US High Yield Index (.MERH0A0).
NO NEED FOR DEFENSIVE DRIVING AROUND THIS PERFORMANCE CURVE (1101 EST/1601 GMT)
Market chatter has recently intensified on the potential for yield curve inversion. Read more
While a flat or inverted yield curve has sometimes predicted the end of a growth cycle in the past, Saira Malik, chief investment officer at Nuveen, thinks the current US expansion is “alive and vibrant”.
From this perspective, Malik says the flatter curve seems more indicative of today’s economic “heat wave” and a nod to the near certainty of associated Fed rate hikes, rather than a “cold snap” on the road.
Malik notes that real interest rates have risen and the real yield curve remains steep, which she says is another indication that bond markets are not worried about a recession. In other words, inflation expectations are pushing up nominal rates in the short term, but investors are confident that “the Fed will keep inflation contained over the long term.”
In terms of what this means for portfolio positioning, Nuveen believes that with a low probability of a recession now is not the time to be defensive.
Additionally, Nuveen does not believe investors should view a curve reversal as a timing signal. Malik says that “the yield curve tends to flatten during up cycles and typically inverts during or after. But historically, even after an inversion, most asset classes have produced healthy returns.”
Therefore, Nuveen believes “it makes sense to maintain a risk-based positioning.” With that, Malik says they continue to favor a shorter duration position (e.g. heavily syndicated and private loans), non-US and US small cap stocks and some private assets (e.g. private equity and real assets).
Malik adds that those who prefer to factor in an inversion may consider “reducing risk by reducing their overall equity exposure and/or favoring low-volatility, income-generating stocks, and extending duration to core bonds.” “.
US STOCKS OPEN HIGHER, UKRAINE AT VIEWPOINT (0957 EST / 1457 GMT)
U.S. stock indexes opened higher on Wednesday as Western nations imposed modest initial sanctions on Russia, as investors focused on the possibility of resolving the Russia-Ukraine crisis diplomatically.
The United States and its allies on Wednesday unveiled new sanctions against Russia for its recognition of two separatist areas in eastern Ukraine, but said it had tougher measures in store in case of an invasion. on a large scale by Moscow. Read more
Stocks rose, however, after the S&P 500 entered correction territory on Tuesday by closing more than 10% below its record close reached on January 3.
Small-cap stocks led the rally, with the Russell 2000 Index (.RUT) rising around 0.78%.
Almost all of the 11 major sector indices in the S&P 500 are green, with gains led by energy (.SPNY), real estate (.SPLRCR) and financials (.SPSY). Utilities (.SPLRCU) is just the red sector, modestly down on the day.
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S&P 500: AS TANGO TRADERS, IT’S CORRECTION VS MOMENTUM (0900 EST/1400 GMT)
The S&P 500 Index (.SPX) ended Tuesday down 10.3% from its record close on Jan. 3. With that, the benchmark confirmed a correction.
The SPX closed at its lowest level since October 4 of last year. However, it has yet to breach its late January intraday low at 4,222.62:
Meanwhile, daily moose readings may offer glimmers of hope. This as a bullish convergence pattern can form on the RSI.
Just looking at the behavior of the RSI around the major lows of the past four years, in October 2018 and February 2020, the oscillator established a deeply oversold low at the start of the declines. Following what turned out to be counter reactions, the RSI failed to muster enough strength to reclaim the overbought threshold. The SPX then went to lows.
Ultimately, in these instances, the SPX bottomed out with the RSI able to form a higher low, as less severe bearish momentum witnessed the deeper SPX levels.
Recently, on January 27, the RSI dipped to 16.082. The SPX then jumped more than 6% in just four trading days. With that, however, the RSI failed to recoup the overbought, and the SPX has now moved to a new closing low.
However, with the RSI ending at 32 on Tuesday, a positive convergence has the potential to solidify with the late January low of 16.082 now the key level for the indicator.
Thus, traders will be watching the dance between the SPX and the RSI closely. Read more
Additionally, it should be noted that the SPX has Fibonacci retracement support for its entire March 2020/January 2022 advance at 4,198.7 and 3,815.2.
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Terence Gabriel is a market analyst at Reuters. Opinions expressed are his own.
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