One Path to a Market Crash: Credit Spreads

High yield credit is outperforming government debt as it did into the 2007 peak. What's amazing is credit has been deteriorating unlike in 2007. The low in 2007 was below the 1997 low, and it produces a peak in the HYG/TLT ratio. The current high is being made with credit risk sitting at the "get out of stocks now" line.

TLT isn't an appropriate comparison fund for HYG in most cases because there's a big duration mismatch, 20 years versus about 5 to 7 years. U use it because it is volatile and these two funds are sort of companion ETFs for income investors the past 13 years. You buy TLT in the corrections, and HYG at the lows. With that in mind, here's another way of expressing this relationship. The high-yield srpead divided by the 10-year and 5-year treasury yields. They're both approaching lows seen in September 2018.

Think of it this way. The decline in interest rates this year has taken companies up to the starting line of panic in the credit markets. Any follow through will trigger the type of fear normally associated with recessions and credit events. At that point, it doesn't matter if treasury yields fall except that falling yields will keep panic limited to corporate bonds.