Much has been written about how shrinking corporate bond yields might fuel an M&A boom, but the performance gap between credit and equities persists, despite the lengthening queue of analysts warning that credit markets have run far enough in the short term.
Andrew Garthwaite of Credit Suisse joined that line on Friday, sending this chart out to clients:
So, the spread on speculative American corporate debt (as measured by the Markit CDX HY index) has rallied from 1,700 basis points back in March to less than 700bps. On Garthwaite’s figures, this market is implying a five-year cumulative default rate of 34 per cent – less than the cumulative default rates seen in the early 90s and after the dot.comedy bust.
Spreads are suggesting that default rates will now fall off, having peaked at below the spikes seen in recent past recessions.
Setting aside the implicit heroism here, Credit Suisse is now saying loud and clear: sell bonds and buy stocks.
We downgrade credit relative to equities, given that: a) Credit spreads now imply default rates below the peaks of the last two recessions. We think this is too low; b) Equities have lagged credit: when investment grade spreads were last at current levels, equities were 26% higher; c) Equities look attractively valued relative to corporate bonds: the equity risk premium is 3.4% above investment-grade credit spreads (the historic average is 2.2%); d) M&A activity looks set to increase, which is good for equities relative to corporate bonds.
Related link:
View of the Day: Jim Reid, Deutsche Bank – FT
‘There’s no free lunch in credit anymore‘ – FT Alphaville