The markets think everything is perfect!
A couple key market measures suggest investors see absolutely no reason to worry. So we’re worried.
We don’t write about corporate bonds very much, largely because it’s a pretty boring market, people don’t understand it, bonds are kind of hard to explain, and readers, for the most part, really don’t care.
But good folks over at the Financial Times have pointed out something interesting that I’ve been meaning to bring up, but never got around to for the aforementioned reasons.
Spreads! Spreads are incredibly tight! Spreads are essentially the difference between the yields on corporate bonds — you can think of that basically as the interest rates US corporations are charged to borrow in the bond market — and the yield on US government bonds, which you can think of as the price the market is charging Uncle Sam to borrow.
Basically the premium — or spread — that private borrowers are paying compared to the federal government is at its skimpiest level in about 20 years.
One way to understand spreads is basically as a gauge of how worried or uncertain investors are.
When the outlook for companies and the economy look dark and foreboding, spreads “blow out,” as they did during the financial crisis and Great Recession of 2008-09, or during the onset of the pandemic.
But when investors seem to see nothing but blue skies and Labrador puppies on the horizon, spreads compress or get incredibly “tight,” to use bond-geek lingo.
And right now, the bond market is in straight-up puppy mode, suggesting that nobody sees reason to worry much about the economic outlook or corporate profit picture.
This is a similar vibe to the one we’re seeing in the stock market where price-to-earnings ratios — a key valuation metric I think of as a sort of measure of how enthusiastic or greedy stock investors are — are hitting some of the highest levels we’ve seen outside of the unmitigated mania of the dot-com boom in the late 1990s.
Now, broadly speaking, the current confidence makes some sense. The economy is incredibly good and, if history is any guide, could get better as the Fed cuts interest rates. Unemployment is really low. Households are really wealthy. Corporate profits are really high. Inflation is slowly falling. What’s not to love?
On the other hand, nervous nellies such as ourselves might just note that when the outlook seems exceedingly excellent, it might not be quite as good as it appears, especially as we head into a pretty consequential presidential election that even The Wall Street Journal says could “radically” reshape the nature of the US economy.
Anyway, just a thought.
