Why Bonds And Stocks Should Not Worry About Recession.‍

A clear message is being sent to investors by corporate bonds: Quit worrying so much about recession - or at least one that will be severe. Stocks may take note of it.

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In order to reach out to investors, the corporate bond market is using a low "credit spread." Credit spreads measure the difference between bonds' yields and risk-free Treasury bonds, which are guaranteed to pay investors on time.

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Bond prices rise as yields decline, which is something investors should remember. A rise in corporate bond prices means lower corporate bond yields, and the difference between them and lower Treasury bond yields isn't much different either.

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Investors demand higher yields in exchange for the risk associated with a company's ability to generate enough profits to repay its debts, which is why spreads are so important. The market perceives minimal risk that a company's earnings will be negatively affected when corporate bond yields are barely above Treasury yields. 

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According to central bank data, investment-grade corporate bond yields are currently around 1.3 percentage points higher than comparable Treasury bonds, down from over 1.7 percentage points last year.

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The Federal Reserve is fighting inflation by paying proper attention to bonds. In order to cool the economy and reduce inflation, the central bank began raising short-term interest rates a year ago.

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In 2022, investment-grade credit spreads increased due to lower corporate profits, which is why cheaper goods and services generally have a downside.

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A deep recession is unlikely, and earnings are expected to hold steady, according to the corporate bond market.  

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It is the same story with high-yield bonds, which are bonds issued by companies whose profits are more vulnerable to changes in leadership or sales that are particularly sensitive to demand. A year ago, their spread was roughly six percentage points, but now it is about 4.2 percentage points.

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During the first year of capital market volatility, analysts at DataTrek wrote that the bond market is less concerned about a decline in profits in the near term. Accordingly, US equities are neutral, or perhaps bullish. 

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Corporate finance's riskiest asset class is equities. One reason for the sensitivity of the stock price to changes in corporate profitability is that companies pay bondholders first, then shareholders.

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In the time since credit spreads have fallen, there is no doubt that the S&P 500 has rallied, and that is definitely true. While yields on corporate bonds remain low, the index may still gain. 

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In part, this is due to the decoupling of stock and bond markets of late. Credit spreads have declined in recent weeks. The price of corporate bonds is relatively high.

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In the meantime, the S&P 500 has fallen below its early-February closing peak of 4179 at just over 4000 points. There is a possibility that the stock market is signaling that credit spreads need to rise and that stocks will go down further.

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Nevertheless, if corporate bonds continue to perform as well as they have, stocks could eventually rise. Bonds are the key to investing for now: Keep an eye on them. 

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