By Steven Hochberg | Elliott Wave International
Conversations about whether or not the Fed will cut interest rates any time soon continue to dominate the airwaves. But we are looking elsewhere for signs about where markets and the economy are headed.
Having observed market behavior for 45 years, we’ve got a lot of historical precedents to lean on. The emerging picture suggests that investors not paying attention may be caught unprepared for an impending change.
The chart below is stunning in its implications.
It shows the spread between the yield on U.S. corporate junk bonds and the yield on 3-month U.S. Treasury bills going back to the 1990s.
Junk bonds, IOUs of companies with the weakest financial structures, currently yield just 2.7% more than the risk-free rate on 3-month U.S. T-bills, which is 5.4%.
This is one of the narrowest spreads in history, revealing a hunger for risk-taking so fervent that investors cannot comprehend a financial environment that will be different from today’s.
Back in February 2007, the junk-yield-to-T-bill-yield spread narrowed to just 2.2%. That extreme coincided with a peak in the S&P 500 Financials Index, which occurred at the forefront of the worst economic and monetary crisis since the Great Depression. Near the end of the crisis, the spread had skyrocketed by a full ten times, to 22.9%, as corporate defaults shot higher and investors panicked into any asset that was perceived to offer safety.
When another widening of this spread starts, investors’ historic complacency toward risk will be replaced by anxiety and eventually panic as financial asset values contract.
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