Credit Market Complacency Gives the Fed Room to Crush the Stock Market

Corporate bond data via St. Louis Fed, chart by Mish

Chart Notes

  • Yields are monthly averages except for current month
  • Current month reflects yields on May 17, 2022

Yield Categories

  • AAA: Top Tier
  • BBB: Lowest Investment Grade
  • BB: Highly Speculative Junk Bonds
  • CCC: Vulnerable to Nonpayment

Complacency Abounds 

  • CCC-rated debt currently yields 12.93% vs the 2008 peak of 39.24%. In 2016, a non-recession year, CCC-rated debt yielded 20.82%.
  • BBB-rated debt currently yields 4.78% vs the 2008 peak of 9.79%. In 2018, a non-recession year, BBB-rated debt yielded 4.73%.
  • BB-rated debt currently yields 6.07% vs the 2008 peak of 15.75%. In 2016 a non-recession year, BBB-rated debt yielded 6.58%.

Yields are rising but largely reflect the mythical soft landing thesis.

Fed Has Room to Hike 

As long as the credit markets remain complacent the Fed has ample room to hike.

And the Fed will continue to hike until there is a recession, a credit event, or inflation comes down.

Which One? 

I suggest the Fed will pause on recession, at least for a few months, and may pause before that if inflation starts to bend. My last call was a pause after a July hike, and I am sticking with that opinion.  

Other bright minds I follow believe the Fed will keep hiking until inflation is way lower unless there is a credit event. 

It’s possible both views are correct. A recession, credit event, and a drop in inflation can all hit simultaneously. 

How Fast Will the Hikes Come?

We are all guessing, but for now assume the Fed gets in a half-point hike in June, and another half-point hike in July. 

That would put the Fed Funds Rate at 1.75-2.00%. 

I am not positive we get that high. A quarter-point hike or even no hike in July is a reasonable shot if retail sales and housing get crushed and inflation moderates somewhat.

The Neutral Rate

Neutral is the Fed rate that neither promotes growth nor attacks inflation.

Many on Twitter keep expressing the idea that the neutral interest rates is close to the CPI.

I assure you neutral is nowhere close to 8% or even 4%. 

Where is Neutral? 

For discussion of the neutral rate, please see The Fed Searches For the Neutral Interest Rate, Where the Heck Is It?

It would not surprise me in the least is neutral was 1.50%. And if so, the Fed is highly likely to overshoot.

If the Fed hikes to 3.0%, I am sure the Fed will have overshot neutral, but I also doubt we get there regardless of inflation.

I would expect some sort of credit event before rate gets that high.

What Next?

That picture is more clear. 

In the short- to mid-term, expect more hikes and much more stock market carnage. 

The stock market is nowhere close to value territory as Target, Walmart, Amazon and other company earnings misses have shown.

Target Plunges 25%, What About Yesterday’s Big Retail Sales Blowout?

For discussion of earnings misses, please see Target Plunges 25%, What About Yesterday’s Big Retail Sales Blowout?

Also see my timely April 30 post S&P 500 Earnings Estimates for 2023 Rise, It Won’t Happen

The technical stock market damage is huge and the fundamentals are very poor. I will post some more charts later today or tomorrow.

This post originated at MishTalk.Com.

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JeffD
JeffD
1 year ago
Stock market PE was 7 in the early 1980s. Lets see how close we can get this time.
TechLover1
TechLover1
1 year ago
Reply to  JeffD
That correlates with interest rates as returns compete with bond returns.
Unless rates go super high, I don’t expect PE to go super low.
tomhtu
tomhtu
1 year ago
Other bright minds? Wow that’s self absorbed lol
Zardoz
Zardoz
1 year ago
Reply to  tomhtu
Would you read his blog if he was dumb?
tomhtu
tomhtu
1 year ago
Reply to  Zardoz
No but who self proclaims? Also he never updates on his failed miners portfolio post.
While he is definitely intelligent. He is one sided and not transparent with everything. Rarely will he say what he got wrong so his credibility is suspect cause u only hear what he gets right
tomhtu
tomhtu
1 year ago
Reply to  tomhtu
Which of course must be measured against the sp500 market index
Jackula
Jackula
1 year ago
Reply to  tomhtu
Its really not a matter of right or wrong just being stimulated to think from different perspectives. For example I always thought his Tesla call was wrong. Elon is probably the #1 manufacturing engineering mind in the world, not smart to bet against him long term. I did get motivated to dig deeper. In the short term right now tho Tesla will get crushed.
MPO45
MPO45
1 year ago
The big tech news was Cisco cut outlook/forecast for rest of year and missed revenue big time. of course, there is a huge backlog caused by supply chain issues so a prudent investor may want to take advantage of this situation and buy a wee bit more or wait and see what happens over the next couple of months.
For me this is a bellwether for business economy and it doesn’t bode well but we’ll need to see.
Put options to the rescue!
TechLover1
TechLover1
1 year ago
Reply to  MPO45
Cisco is indeed a red herring and representative of corporate growth/spending plans. This is a good indicator of what is about to come.
TexasTim65
TexasTim65
1 year ago
Reply to  TechLover1
I think you mean a canary. A red herring means a false indicator.
Gordofeo
Gordofeo
1 year ago
Here is a chart of BBB spread vs. treasury, which shows true credit risk as it subtracts the “risk free” rate. I tried pasting the chart but couldn’t. The high was 5.73% in 2008 followed by 2.77% in March 2020. For reference, the taper tantrum high was 1.86%. Currently, the spread is 1.88. Interesting that successive record lows were printed just about every month during Q4’20 to Q3’21.
Cocoa
Cocoa
1 year ago
AAA high grade corps are probably going to be your best bet in this overall market. Credit spreads are widening as seen here:
creditspreadalert.com
OUdaveguy
OUdaveguy
1 year ago
I always appreciate the deep insight and honesty on this blog. It would be great seeing a consolidated list of pros and cons the Fed faces with regards to interest rate changes. An interactive dashboard showing the second and third order effects on governments, institutions, pensions, leverage, credit ratings, etc. would be the piece de la resistance.
MPO45
MPO45
1 year ago
Reply to  OUdaveguy
Let me try:
The Fed raises rates, we’re all screwed.
The Fed lower rates, we’re all screwed.
Play around with the settings.
Six000mileyear
Six000mileyear
1 year ago
That chart shows yields on AAA and BBB recovered from their COVID panic buying lows. BB and CCC never recovered from COVID panic buying. So the bond market has not only been complacent, but it has also taken on MORE risk by rotating out of AAA / BBB into BB / CCC.
JeffD
JeffD
1 year ago
Reply to  Six000mileyear
Kiss your pension payments goodbye.
Doug78
Doug78
1 year ago
Happens a lot these days
LPCONGAS99
LPCONGAS99
1 year ago
Mish, anyone, can you explain to me how crushing the U.S. Stock market is somehow going to make things better?
Siliconguy
Siliconguy
1 year ago
Reply to  LPCONGAS99
If the stock market is crushed then people will feel poorer, and that means they will buy less, which will decrease demand, and that will lower inflation.
Just push the I Believe button and all will be well. 🙂
killben
killben
1 year ago
Reply to  Siliconguy
It is all about crushing demand.
Stock market and housing are the only 2 areas that the Fed can do something regards crushing demand and thus inflation. Housing has just started.
Food, oil, supply chain are beyond its control.
Recession also reduces demand via job losses.
Also inflation is a political hot potato (everywhere) and thus whether you can do something or not about it you cannot sit still, you need to be seen as doing something whether it works or not.
Especially when you have been saying it is “transitory” during 2021
Bam_Man
Bam_Man
1 year ago
The many pension funds that have “diversified” into stocks will soon start blowing up if the stock market drops another 10-15%.
Can you say “deflationary demand destruction”?
I knew you could.
vanderlyn
vanderlyn
1 year ago
fed in past 50 years has never broadcast so loudly past few months they are gonna jack up rates to crush inflation. folks that wanted to believe it was a bluff for a host of reasons like stocks and such were drinking their own koolaide. this was so broadcast. like ignoring tsunami warning sirens and keeping your blanket on waikiki……..it’s gonna be great to give investors high yields to invest and buy homes and stocks and even food at lower prices in years ahead. might be 5 or ten years stagflation ahead.
lkurek
lkurek
1 year ago
What is going to happen to all that stock that was bought back with debt/bonds on these companies financials? Good luck re-capitalizing in a down market.
Bam_Man
Bam_Man
1 year ago
Reply to  lkurek
EVERY one of those companies goes bankrupt when the day comes to roll over that debt.
Which is why rates will never be allowed to get that high.
Six000mileyear
Six000mileyear
1 year ago
Reply to  lkurek
The existing bond holders become the new equity holders.
FromBrussels
FromBrussels
1 year ago
First of all, deluded investors and/or algos, should lose faith in utmost, based on absolutely nothing, fair weather idiocy called crypto…. from there onwards it is time to have a critical look at the insane CBs money printing policy that’s been going on for more than a fn decade now, creating a, at least 50%, overvalued stock index and housing prices …..Central Banks should STOP interrupting healthy economic cycles ….one can t stop a boomerang from coming back …screwed we are….
Zardoz
Zardoz
1 year ago
Reply to  FromBrussels
Comrade Yoda! It is time to return to fatherland! Potato and outhouse await!
Tony Bennett
Tony Bennett
1 year ago
“A recession, credit event, and a drop in inflation can all hit simultaneously.”
Bingo.
Finally, some red when I look at commodities.
Can’t figure out why …
Crenvy
Crenvy
1 year ago
Reply to  Tony Bennett
Baby with the bath water?
Most of the commodity surge of late, including energy, is based on perceptions of supply side problems, but at some point demand destruction has to take effect.
Anyone with a link to analysis of the tradeoffs there?
Tony Bennett
Tony Bennett
1 year ago
Reply to  Crenvy
I’m an advocate of “It’s All One Trade” … and has been for a while.
To tame inflation the stock market must fall. Hard.
Cocoa
Cocoa
1 year ago
Reply to  Tony Bennett
So FED is creating a deflationary event-which has so far to fall that it could be a depression(with all it’s usual splinter events like war, political upheaval and misery). What a great institution. FED will give up soon I suspect when the deleveraging hits very hard
PapaDave
PapaDave
1 year ago
Reply to  Tony Bennett
Lol! A great day to buy back the oils that I sold in the last few days. I love this volatility. Making a fortune with it in my trading positions.
Meanwhile oil inventories continue their 2 year long plunge. Still waiting for that “demand destruction” to stop the fall in inventories. Wonder when that will happen? Maybe at even higher oil prices?
Roadrunner12
Roadrunner12
1 year ago
Reply to  PapaDave
realist/imgreen/papadave/mpo45
What are your thoughts as to anyone who took your advice to get into housing at the peak a few months ago. Maybe the situation in Detroit and Chicago is better?
Real estate: Market slowdown brings buyer’s remorse | CTV News (Ive been link sanctioned, google preceding)
TORONTO –

A wave of buyer’s remorse is taking shape in several heated real estate markets, after housing prices started dropping and the number of sales slowed over the last two months.

Realtors and lawyers in Toronto and Vancouver say they have noticed buyers looking at what options they have to get out of a purchase and sellers hoping to ensure one goes through because conditions have shifted dramatically from the previous highs and frenzied pace.

The country experienced a 25.7 per cent drop in the number of homes sold over the last year and a 3.8 per cent slide in housing prices between March and April, the Canadian Real Estate Association said Monday. The average home price last month totalled $741,517.

Such numbers have prompted some sellers to explore lawsuits to ensure transactions move forward and other purchasers to worry about the value of pre-sale properties they bought years ago but have yet to take possession of.

“With today’s real estate prices, there’s really no option but to go all in and if you’re going all in, and then suddenly you’re realizing that perhaps you made a bad bet and there’s a way out of that bet, you’re going to do whatever you can to get out,” said Mark Morris, a Toronto real estate lawyer.

In recent weeks, he has seen nine cases where buyers want to back out of deals but on Monday alone was approached by three sellers keen to use legal channels to keep purchasers from walking away.

Morris doesn’t call the encounters a trend because it’s unclear how many other lawyers are seeing the same spate, but three queries in a day is his new record. He used to see one case of that nature every few months.

“Purchasers are looking at the existing crisis, and in the best of times, they feel they overpaid, but now they have objective proof that they’ve done so because markets have started to pummel and fall and really shows no signs of slowing down,” said Morris.

“Many of those buyers are faced with the option of moving forward or upping and walking.”

People get “spooked” every time the market turns and explore what they can do about deals they signed, but few end up walking away because it’s hard to get out of such transactions, said Phil Sopher, CEO of Royal LePage.

He thinks the exception to this pattern came in 2020, when the COVID-19 pandemic broke out and people wanting out of transactions had so many unknowns on their side.

Most buyers trying to end a deal this year won’t be successful because there is no legal way out, but such cases are also impractical for sellers, Morris said.

…………………………………………..
PapaDave
PapaDave
1 year ago
Reply to  Roadrunner12
I do not think I have commented on housing or real estate. My focus is on oil stocks.
MPO45
MPO45
1 year ago
Reply to  Roadrunner12
MPO45 and PapaDave are not the same person but clearly you can’t tell the difference. I have a rental properties and I have zero remorse. My rental properties are generating income, essentially the tenants are paying my mortgage and giving me a small profit. These properties will be handed down to my kids and they can sell them or generate income from them.
I understand you like gold as an investment. Good for you, if you are happy with gold, keep buying it, I don’t care. It just seems odd that your whole investment strategy is just gold, that is one dimensional thinking but your linear thoughts confirm that bias. You got 8.5% return and inflation is at 10%? Good luck to you.
Here is a summary of my portfolio:
Oil stocks: BP, XOM, CVX
Tech stocks: Cisco, Apple
Other Dividend stocks: Prudential, Walgreens, various REITS, and smaller positions in other high yield dividend stocks (too many to list).
Rental properties – these were bought with 3% mortgages in value priced areas. I never paid more than 150k for a property so that should tell you a whole lot about my due diligence. Most properties are worth over 200k, one is 300k and generate at least 1500 in rent or more.
Cash – I am 2/3 in cash and 1/3 in the investments above. I like to keep a lot of power dry to take advantage of panics like this. I will buy more stocks all the way down and be looking for real estate that’s reasonably priced. Go over to Zillow and look for a 4 bed house in San Francisco and then go look at say Bay City, Michigan for a 4 bedroom house. You tell me where the value is, I know I’m asking a lot from a one-dimensional linear thinker but I think you can manage it if you try.
“Be greedy when others are fearful and be fearful when others a greedy.” – Warren Buffet
Esclaro
Esclaro
1 year ago
Reply to  MPO45

Gold? What a joke. The dollar is killing gold. Gold is the old man’s crypto.

MPO45
MPO45
1 year ago
Reply to  Esclaro
I forgot to mention that I do have some gold in the form of GDX (gold miners ETF). I bought this in the panic of 2008 and I am still underwater on the price I paid for it but I’ve been getting nice dividends from it so I’ve kept it. At this point, it will stay in my portfolio till I die then hand that down to the kids.
I do have some gold coins that have sat in a vault for 30+ years doing nothing but collecting dust. I should have bought bitcoin instead.
Jmurr
Jmurr
1 year ago
Reply to  MPO45
1/3 gold, 1/3 cash and 1/3 short
Tony Bennett
Tony Bennett
1 year ago
Reply to  PapaDave
Anyone who feels the need to (incessantly) brag on their trades reveals a “short guy” complex … just sayin’ …
PapaDave
PapaDave
1 year ago
Reply to  Tony Bennett
I will continue to explain my strategy on oil stocks in the comments section. After all, I learned it here on this blog. You are welcome to criticize it, praise it, follow it, or whatever you want.
Roadrunner12
Roadrunner12
1 year ago
Reply to  PapaDave
papadave/realist/imgreen/mpo45
Im wondering on your strategy recommending housing at the peak?
“2. $10k first time home buyer incentives.”
What impact do you think this will have on the housing market?
PapaDave
PapaDave
1 year ago
Reply to  Roadrunner12
I have not recommended housing or real estate. Just oil stocks. Can you show me where I did please? I don’t know what incentive you are talking about.
Roadrunner12
Roadrunner12
1 year ago
Reply to  PapaDave
Unfortunately your realist/imgreen posts were deleted. It is beyond me why you want to play this message board as a yahoo penny stock pump using multiple aliases. Do you really believe your fooling anyone masqurading now as mpo45/papadave etc.
But back to the point on housing, recommending housing at the peak has to be one of the most stupidest calls, Ive seen on this board. What are you thoughts on your post stating a $10,000 first time home buyers incentive would have on the housing market?
I do have my reply to your buy a house at the housing bubble peak though?
Comment on:
N/A
3 months ago
“Own a house and participate in the increase in value of this asset class.”
“Invest in the stocks of oil and gas companies. “
“Buy gold? I wouldn’t recommend that.”
We are in a major housing bubble. I expect many are gonna get burned just like in 2008.
Oil and gas has done well and the easy money has been made. Although oil and gas outlook looks to be good for oil companies, I believe there is still a major recession/depression to play out.
Im not sure why if you are so against gold why you own some. Your saying you own gold but dont recommend people have gold is a confusing stance.
I am quite happy making 8.5% in my gold stash over the last 15 years and expect that to continue.
Meanwhile I do admit buy the dip has played out well, I do expect that to change and I expect the Buy the Dippers to lose their shirt at some point.
Do you think we are in a housing or stock market bubble?
PapaDave
PapaDave
1 year ago
Reply to  Roadrunner12
Whatever. Believe what you want. I have no opinion on housing. You will have to ask someone else.
Christoball
Christoball
1 year ago
Reply to  PapaDave
“””””Lol! A great day to buy back the oils that I sold in the last few
days. I love this volatility. Making a fortune with it in my trading
positions.
Meanwhile oil inventories
continue their 2 year long plunge. Still waiting for that “demand
destruction” to stop the fall in inventories. Wonder when that will
happen? Maybe at even higher oil prices?””””””
This reminds me of an episode of Happy Days where Fonzi is giving comfort to Richie Cunningham about a date that did not turn out as steamy as he hoped for. Everyone thought that Richie had hit a home run with this girl but Richie knew the truth that they had a pleasant time just enjoying each others companionship. Richie felt the tension between the truth and others fiction and did not know how to reconcile it.
Fonzi always knowing what to say next, asks Richie….. Which is better???? That you slept with this girl???? Or that everyone else thinks you slept with this girl?????…. Richie replies, I guess your right Fonzi, it is more important that everyone thinks I slept with her.
Such is the case with always telling past trades showing current success. It is more important for some people to have others think they are successful than whether they are actually successful or not.
As to whether papadave/realist/imgreen/mpo45 are the same person we will never know for certain, but it does remind me of the over the top scene in the movie “Pet Detective” where the detective discovers that Finkle is Einhorn, Einhorn is Finkle!
As long as we are sharing investment locker room stories, don’t get me started about the time I bought American Airlines for 38 cents share in 2011and it went up 30 times that amount. Did I keep it that long??? or did I sell it after tripling my money. I did actually buy it but hindsight allows me to say whatever I want. The truth is I only had pleasant companionship with it for a couple of weeks and sold for $1.49.

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