Despite a respite in global equity prices month to date, last week saw some major breakdowns in the uber-important credit markets which likely confirms more downside to come in the current correction.
Globally, it was a bloodbath in high yield with risk premiums achieving year to date highs.
Figure: Bloomberg Barclays Global High Yield Option-Adjusted Spread has broken out (or broken down depending on your perspective)
On the other hand, global equities did not follow suit as they have historically. The inference here is that if a measure of global credit risk is hitting annual highs, then global equities should eventually be hitting annual lows.
Figure: The MSCI ACWI remains above its October lows (Source: Stockcharts)
In the US, the all-important Leveraged Loan Index, which serves as the reference point for a number of leveraged capital ‘structured’ product like Collateralized Loan Obligations (CLOs), saw the first break of its 50 day moving average in nearly two years! The leveraged loan market had been a refuge for institutional investors this year – no longer. I don’t traffic in CLOs anymore, but if past is prologue, this market probably froze up last week (if not earlier) with a severe widening of bid/offer spreads.
Figure: Credit Suisse Leveraged Loan Total Return Index (Source: Bloomberg)
The only question that remains is whether investors will have time to exit like in 2014 or whether we’re witnessing something more pernicious like in the second half of 2015 where much of the CLO market was bid down 20%-50% in a span of six months (remember this is up to 10X+ leveraged to Loans). I think my views on the current cycle are pretty well established by now but I’ll post our Market Cycle Monitor where you’ll see that the “Cheap Zone” acts like a magnet in every market cycle; each different in flavor, but all yielding the same outcome across the multi-asset class spectrum. Unlike the prior two “mini-cycles” in 2011 and 2014-15, the current conditions appear to be far more dangerous.
Liquidity is great when you have it, not so great when you don’t! Plan accordingly.
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