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Cracks in the high yield market could be sending an ominous message to the markets.
According to Oppenheimer technician Ari Wald, since 1990 when the high yield and 10-year Treasury yield spread has widened, the S&P 500 is more vulnerable to market pullbacks.
“Historically we found that the market is more vulnerable to downside shocks and volatility when spreads are widening,” he said Thursday on CNBC’s “Trading Nation.” “One example of that was May 2015. The market was at a new high, high yield credit spreads were widening for a year, so there’s a lead tide here.”
Wald noted that on a chart of the high yield credit spread versus the S&P 500, the spread has reached a key level that leads him to believe it could be the “next pillar to crack.” As a result, he encourages investors to rotate out of high yield and into treasuries. However, Wald stresses that he is still bullish on stocks but is watching the S&P 500 “as we are now in year 3 of what is typically a 3-year bull cycle.”
Strategic Wealth Partners CEO Mark Tepper, however, believes that the fundamental picture for the markets makes the high yield spread a less ideal metric for predicting the market’s next moves.
“Now obviously a widening spread suggests that there’s this risk off mentality that we’re experiencing right now,” said Tepper on “Trading Nation.” “And I think given trade tensions, that widening makes sense because investors are going to need increased yields to compensate them from taking on added risks.”
“So because of that, I really don’t feel like you can use this metric as a predictor of future returns because the results of trade tensions are still unknown,” he added.
In fact, Tepper says that investors should actually remain in risk assets, which includes high yield and stocks, as margins are still rising. But once those margins do peak, says Tepper, there is a “small time frame following the peak of margins until the next recession [when] all risk assets are going to produce negative returns.”
The S&P 500 hit a four-month high on Friday, trading as high as 2,801.90.