Credit market pain is too muted to save stocks

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Federal Reserve officials do not seem particularly concerned about falling stock valuations. However, they are sensitive to major movements in the credit markets. The central bank would likely backtrack on its aggressive monetary policy tightening plan if U.S. businesses show signs of struggling to raise debt.

But despite some historic losses in credit markets this year, we are not far off. Corporate balance sheets are in some of the strongest positions in 20 years, and defaults are expected to remain “comfortably below” the long-term average of 4% this year, Goldman Sachs Group Inc analysts wrote. in a note last week. Bank of America Corp. credit analyst Eric Yu agrees. “Even if we head into a recessionary scenario, we expect high-yield defaults to peak at less than 6%,” he wrote in a research note last week. “We suggest taking a lot more risk here.”

Even the Fed’s quarterly survey of bank loan officers shows a willingness to lend. No bank reported a significant tightening of lending standards in the latest survey, even with higher interest rates and concerns about higher inflation and a slowing economy. Lenders have confidence because companies aren’t desperate to borrow now to stay afloat. Above all, they took advantage of historically low rates to refinance a large part of their bonds, pushing maturities back years into the future.

It’s not like there hasn’t been any pain or worry. Investment-grade U.S. bonds are down 13.4% this year, and high-yield, junk or junk bonds are down 10.4%, according to the Bloomberg indices. But the losses were mainly due to a broad price revision linked to higher rates on US Treasuries rather than concerns about deteriorating credit quality and potential defaults. Excluding the government debt component of returns, junk bonds are up 0.7% and investment grade bonds are down only 0.5%.

Normally, these signals would favor equities and other riskier assets, since credit is an indicator of corporate health and tends to dominate other markets. But in this case, the generally resilient credit market has become a liability for equity investors. That means the bar is all the higher for the Fed to back down from its plans to aggressively hike interest rates and strip liquidity from the financial system by shrinking its balance sheet by nearly $9 trillion.

As it stands, equities are being buffeted by inflation-adjusted Treasury yields above zero for the first time since before the pandemic began, making equities less valuable on an adjusted basis. at risk. For example, the S&P 500’s dividend yield is near the lowest since May 2019 compared to actual 10-year Treasury yields, which climbed to 0.18% from a low of -1.08. % in March.

Stocks are also being criticized by the prospect of slowing economic growth, rising labor and raw material costs and prolonged supply chain disruptions. Some historical havens, namely the US tech giants, have seen disproportionate declines in their stock prices, with the Nasdaq Composite Index firmly in a bear market, falling 26.5% from its peak in November.

On the other hand, borrowers in the corporate bond market may find it easier to repay their debts given the increase in nominal incomes and gross domestic product due to inflation. Investors could swing into a period where credit offers better protection than equities against slowing economic growth and accelerating inflation. After all, high-yield bonds are actually providing the income so many investors have been clamoring for, offering average yields of 7.6%, near the highest since May 2020. Investment-grade bonds are offering the highest yield since March 2020, at 4.4%.

There is no credit crisis, and it would take an unforeseen event for it to become one anytime soon. Corporate bond investors are finally earning the income they’ve been dreaming of with little risk of not being paid in full and on time. This is positive for them, but for stock market investors, the situation has evolved in the opposite direction. Without more trouble in credit, stock markets cannot count on the Fed to back off from its monetary tightening plans just to avoid further losses.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Lisa Abramowicz is co-host of “Bloomberg Surveillance” on Bloomberg TV.

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