I commented last week on the value of credit spreads – credit stress, economic conditions, as a possible buy indicator. This week I came across some graphs that indicate some correlation with the equity market.
The first is the TED spread. I mentioned this in the last post, but the TED spread is an indicator of credit risk essentially reflecting the difference in yield between short-term corporate borrowers and Treasury Bills. The higher the spread, is the greater the risk in the credit markets.
The graph here (via Infectious Greed) shows the inverted TED spread versus the S&P 500. If you look at the graph, as the TED spread moves higher equities in general move lower.
Another graph that caught my eye shows the High Yield spread (High Yield Bonds over Treasuries) versus the S&P 500. Again, as the spread moves higher equities in general move lower.
Now looking at both graphs you can see the TED and HY spreads are trending wider. Is this bearish for equities? Not necessarily as these spreads appear to coincide with stocks (i.e. one is not leading the other).
Thus, when the spread and stocks diverge from their past correlations (as both of the aforementioned do now) it is a decent indication that one of those markets is due for a correction – one way or the other.
