Closing Thoughts for the Week

I think we really need to watch high yield credit spreads very closely here. My belief is that the consumer is getting tapped out and is likely to be the factor that tips the economic scales in the other direction. Next week’s retail sales report will be important. Small-caps are already lagging large-caps and if junk bonds begin underperforming too, it could be a sign that we’re seeing a genuine turn in market conditions that perhaps give fuel to safe haven trades.

The primary market theme right now continues to be the destruction of rate sensitive assets as long-term Treasury yields keep moving higher. With Treasuries and utilities underperforming so badly recently, it’s opened the door for short-term risk-on behavior in large-caps, which is exactly what we’ve seen happen. We could see both short-term and long-term signals converge in a risk-off manner sometime during the second half of October.

I talk often about how path matters more than prediction and this past week was a great example of that. I said recently that I believe the credit event has begun. If I’m correct on that, this past week’s underperformance of utilities will likely be irrelevant in the long-term. The “un-inversion” of the yield curve has been happening in a major way pretty much since the end of May, so we may be seeing investors finally begin to price in recession risk.