One of the best coincident and real-time indicators of bursting bubbles and recessions is the yield spread between U.S. high-yield corporate bonds and the 10-year U.S. Treasury. It isn't flashing code red just yet, but it has gone to orange from green over the past year. The yield on the Merrill Lynch junk bond composite is up 205 basis points to 7.21% from last year's low of 5.16% on June 24. The yield spread has widened to 501 basis points from 257 points 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 might or might not be warranted. It might 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 to 2.05 from 3.14 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 Oct. 21, 2014, at 46.5%.
Source: Ed Yardeni — Ed Yardeni is the president and chief investment strategist of Yardeni Research Inc., a provider of independent investment strategy and economics research for institutional investors.